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Stuart Daggett

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HARVARD UNIVERSITY
Cambridge, Mass., U.S.A.

HARVARD ECONOMIC STUDIES

PUBLISHED UNDER THE DIRECTION OF
THE DEPARTMENT OF ECONOMICS

VOL. IV

RAILROAD
REORGANIZATION

BY
STUART DAGGETT, Ph.D.

INSTRUCTOR IN ECONOMICS IN HARVARD UNIVERSITY

BOSTON AND NEW YORK
HOUGHTON, MIFFLIN AND COMPANY
The Riverside Press, Cambridge
1908

COPYRIGHT 1908 BY THE PRESIDENT AND FELLOWS OF HARVARD COLLEGE ALL RIGHTS RESERVED Published May 1908

PREFACE

It sometimes happens that experiences long since past seem to be repeated, and that knowledge apparently forgotten proves again of service. This is illustrated by the subject of railroad reorganization. In the years between 1893 and 1899 an imposing group of American railroads passed into receivers’ hands. In 1893 alone more than 27,000 miles, with an aggregate capitalization of almost $2,000,000,000, were taken over by the courts, and in the following years the amount was largely increased. Foreclosure sales aggregated 10,446 miles in 1895, 12,355 in 1896, and 40,503 between 1894 and 1898. Among the more important failures were those of the Richmond & West Point Terminal, the Reading, the Erie, the Northern Pacific, the Atchison, and the Baltimore & Ohio;—to say nothing of the Norfolk & Western, the Louisville, New Albany & Chicago, the Ann Arbor, the Seattle, Lake Shore & Eastern, the Pecos Valley, and many other smaller lines.

The railroads which failed between 1893 and 1898 were subsequently reorganized. In order to restore the equilibrium between income and outgo the companies turned to their creditors, and demanded the surrender of a part of the rights of which bondholders were then possessed. This demand the creditors were forced to concede. Some of them yielded without legal compulsion, assenting to “voluntary reorganizations”; some insisted upon the sale of the property securing their loans, but without escaping the loss which fell upon their more pliant associates. Much injustice to individuals came to light at this time. Men who had invested in good faith were obliged to sacrifice their holdings through no fault of their own. The savings of years were swept away. The demand of the railroads was one, nevertheless, which the courts supported, and rightly. The companies could not be operated unless the creditors were deprived of part of their legal rights. At the same time, these rights no longer had a material basis on which to rest, and their surrender meant but the recognition of a loss which had already taken place.

Most of the reorganizations were completed by the year 1899. Since that date the improvement in railroad earnings has been marvellous. Gross earnings from operation were $1,300,000,000 in 1899, they were $2,300,000,000 in 1906, the last year for which the figures of the Interstate Commerce Commission are at present available. Total income, after the deduction of operating expenses, was $605,000,000 in 1899, and $1,046,000,000 in 1906. It is not to be wondered at that the distress of the years 1893–9 has not been duplicated during the years 1900–7. On the contrary, weak roads have had opportunity to strengthen their positions, and strong ones have spent enormous sums for improvements, and have declared liberal dividends besides. In no year save 1905 has the new mileage put into receivers’ hands been greater than 800 miles, and in but one has the mileage sold at foreclosure equalled that figure. Operating expenses have increased because the amount of business has exceeded the ability of the railroads to handle it. Equipment has been so inadequate as to provoke drastic legislation by the legislatures of many states; yards and terminals have been crowded until a prominent railroad officer has declared the expenditure of over five billion dollars to be necessary to restore the equilibrium between facilities and traffic.

These conditions have caused the earlier problems of failure and reorganization to be lost to view. Nevertheless, the financial panic of October, 1907, and the recession in activity which has become more and more apparent since that time, have again brought these problems forward. The Seaboard Air Line, one of the important railroad systems of the South, failed on January 5, 1908. The Chicago Great Western followed three days later. The Detroit, Toledo & Ironton, the Chicago, Cincinnati & Louisville, the International & Great Northern, the Western Maryland, and the Macon & Birmingham have since been put in receivers’ hands. In all, the operation of 5938 miles of railroad, with a capitalization of nearly $415,000,000, and total liabilities of $462,000,000, has been taken over by the courts during the first ten weeks of 1908. Whether this is but the beginning of still more extended trouble it is of course impossible to say. There are a number of weak lines in the American railroad system, and the difficulty in obtaining credit is bound to reveal weaknesses where they exist. At present new loans have for some months been difficult to obtain, and even strong railroads have resorted to the issue of short time notes. The Erie, indeed, escaped bankruptcy on April 8, 1908, only through the timely aid of important bankers who took up its maturing notes. This points to serious consequences for the weaker lines. It is true, on the other hand, that American railroads are generally in better financial and physical condition than they were in 1893. It is not probable that any railroad collapse will be so widespread now as it was then. Whether this be so or not, the failure of nearly 6000 miles of railroad in ten weeks invests reorganization problems at present with an importance which they have not had for ten years. How, it will be asked, shall the financial operations necessary to reorganization be performed? What methods shall be adopted, what dangers avoided, and what results expected?

The experience of earlier years will provide answers to many of the questions asked in 1908. In the hope, therefore, that a study of railroad reorganization, on which the author has been intermittently engaged during the last six years, will prove of service, the following pages have been published. They discuss in some detail the financial history of the seven most important railroads which failed from 1892–6, and that of one railroad, the Rock Island, which was reorganized in 1902; and summarize in a final chapter the characteristics of the various reorganizations in which these roads have become involved. In some respects the history of each road considered is peculiar unto itself. The Reading had coal to sell, the Atchison did not. The Southern ran through a sparsely settled country, the Baltimore & Ohio through a thickly settled one. The Erie has never recovered from the campaigns of Gould, Drew, and Fisk from 1864–72, the Northern Pacific was not opened until 1883. In other respects, however, the roads have had much in common. Excepting only the Rock Island, each of them has found itself at one time or another unable to pay its debts, and has had to seek measures of relief. The problems of the different companies at these times have been strikingly alike. However caused, their financial difficulties have been expressed in high fixed charges, and, usually, in excessive floating debts. Greater annual obligations have been assumed than the roads could meet, and current liabilities have accumulated while pressing demands have been satisfied. To this state of affairs the remedy has been sought in comprehensive exchanges of old securities for new. The exchanges, it is true, have been carried out in different ways, and the collateral expedients employed have not been the same. To similar problems different solutions have been applied. It is possible, for this very reason, for a careful study of the alternative reorganization methods which have been developed to point out some policies which have been dangerous, and to make clear others which are both just, and likely to be successful. Such a study also throws light upon the history of the companies upon which it is based.

For the way in which the different roads have been handled, the reader is referred to the text. The order of treatment is very roughly determined by geographical location; that is, the Eastern roads are first considered, then the Southern, and then the Western. Each chapter, except the last, should be examined as a “case” in reorganization experience, and as part, therefore, of a united whole. No one has been so continuously with his work as the author himself, and no one can more keenly realize its defects. It is offered as a contribution in a field in which very little has as yet been done, and it is hoped that it will prove of value to those concerned with reorganization plans, as well as to those interested in the development of corporation finance during the last generation.

Without the unselfish and intelligent assistance of the writer’s Mother, the preparation of this book would have been long delayed. To her, first of all, thanks are due. To Professor William Z. Ripley, of Harvard University, should be made warm acknowledgment of his constant interest and helpful suggestions. To the Carnegie Institution the author is indebted for grants in aid of research in this special field. Grateful acknowledgment should also be made of gifts by friends of the University to cover the expenses of publication.

CONTENTS

CHAPTER I Baltimore & Ohio

1

Early history—Extension to Chicago—Trunk-line rate wars—Effect on the company—Extension to New York—Sale of bonds to pay off floating debt—Unsatisfactory traffic conditions—Receivership—Mr. Little’s report—Reorganization—Subsequent history.

CHAPTER II Erie

34

Early history—Reorganization—Wall Street struggles—Financial difficulties—Second reorganization—Development of coal business—Extension to Chicago—Grant & Ward—Financial readjustment—New York, Pennsylvania & Ohio—Third reorganization—Later history.

CHAPTER III Philadelphia & Reading

75

Early history—Purchase of coal lands—Funding of floating debt—Failure—Struggles between Gowen and his opponents—Reorganization—Second failure and reorganization.

CHAPTER IV Philadelphia & Reading

118

Difficulties of the Coal & Iron Company—McLeod’s policy of extension—Collapse of this policy—Failure of company—Summary of subsequent history.

CHAPTER V The Southern

146

Richmond & Danville—East Tennessee, Virginia & Georgia—Formation of the Southern Railway Security Company—Growth and combinations—Failure and reorganization of the East Tennessee—Reversal of position between the Richmond & Danville and the Richmond & West Point Terminal—Acquisition of the Central of Georgia—Failure and reorganization of the whole system—Subsequent development.

CHAPTER VI Atchison, Topeka & Santa Fe

192

Charter—Strategic extensions—Competitive extensions—Effect on finances—Raise in rate of dividend—Reorganization of 1889—Acquisition of the St. Louis & San Francisco and of the Colorado Midland—Income bond conversion—Receivership—English reorganization plan—Mr. Little’s report—Final reorganization plan—Sale—Subsequent history.

CHAPTER VII Union Pacific

220

Acts of 1862 and 1864—High cost of construction—Forced combination with the Kansas Pacific and the Denver Pacific—Unprofitable branches—Adams’s administration—Financial difficulties—Debt to the Government—Receivership and reorganization—Later history.

CHAPTER VIII Northern Pacific

263

Act of 1864—Failure and reorganization—Extension into the Northwest—Villard and the Oregon & Transcontinental Company—Lack of prosperity—Refunding mortgage—Lease of Wisconsin Central—Financial difficulties—Receivership—Legal complications—Reorganization—Subsequent history.

CHAPTER IX Rock Island

311

Charter—Early prosperity—Reorganization of 1880—Conservative policy—Extension—Pays dividends throughout the nineties—Moores obtain control—Reorganization of 1902—Further extensions—Impaired credit of the company.

CHAPTER X Conclusion

334

Definition of railroad reorganization—Causes of the financial difficulties of railroads—Unrestricted capitalization and unrestricted competition—Problem of cash requirements—Problem of fixed charges—Distribution of losses—Capitalization before and after—Value of securities before and after—Provision for future capital requirements—Voting trusts—Summary.

RAILROAD REORGANIZATION

CHAPTER I
BALTIMORE & OHIO

Early history—Extension to Chicago—Trunk-line rate wars—Effect on the company—Extension to New York—Sale of bonds to pay off floating debt—Unsatisfactory traffic conditions—Receivership—Mr. Little’s report—Reorganization—Subsequent history.

The Baltimore & Ohio Railroad was the first important railway company to be incorporated in the United States. It was designed to aid the city of Baltimore in securing the Western trade, and not only private citizens but the city of Baltimore and the state of Maryland early subscribed to its stock. When in the course of construction it became expedient to extend into Virginia, the city of Wheeling and the state of Virginia likewise subscribed, though the action of the latter was subsequently withdrawn.1 As a result the funds required for first construction were obtained from the sale of stocks instead of bonds. In 1844, seventeen years after the granting of the charter, the annual report showed $7,000,000 in stock as against $985,000 in 6 per cent bonds; while in 1849, though the loans had been increased, they yet stood in the proportion of one to two.2

On December 1, 1831, the first train was run over the line, then 72½ miles in length.3 The early history of the road does not much concern us. It was one of steady growth, not through an unsettled territory, as with our Western roads, but through a country the industries of which were already established. Tracks led, not into prairies, but to populous cities; and the future of the company, once the initial difficulties should have been overcome, was at no time uncertain. Thus extension to Cumberland increased the gross receipts from $426,492 to $575,235, and that to Wheeling in 1853 likewise brought a great increase in traffic.

The Civil War bore upon the Baltimore & Ohio heavily because of the peculiar location of its mileage. On May 28, 1861, possession was taken by the Confederates of more than one hundred miles of the main stem, embracing chiefly the region between the Point of Rocks and Cumberland.4 Government protection was temporarily restored in 1862, but raids occurred until the end of the war. Each time the Confederates occupied the line they tore it up, and as soon as they retired the company hastened to make repairs. The road did not default. A portion of the track yielded a revenue from first to last, and presumably the Government paid generously for the transportation of its troops.

It was after the Civil War that the real history of the road began. The key-note was competition;—competition of the fiercest sort between parallel lines from Chicago to the seaboard, intensified by the rivalry of the great seaboard cities, and involving traffic in both directions. The decade 1850–60 had seen the extension of Eastern roads to Western connections. In 1851 the Erie had reached Lake Erie; in 1853 the New York Central and Lake Shore, and in 1855 the Pennsylvania and Fort Wayne had opened continuous routes from the Atlantic to Chicago. In 1857 the Baltimore & Ohio had obtained connection with Cincinnati and St. Louis; and in 1858 the Grand Trunk had arrived at Sarnia on its way from Portland to Chicago. After the Civil War there was both consolidation and extension. The New York Central was united with the Hudson River, and the Pennsylvania leased the Pittsburgh, Fort Wayne & Chicago in 1869. The Baltimore & Ohio reached Chicago in 1874, and the lines which in April, 1880, were consolidated into the Chicago & Grand Trunk were completed between Port Huron and Chicago in February of that year. The completion of these through routes opened the way for very bitter competition. Five independent lines struggled for Chicago business, and all of them were prepared to cut rates deeply in order to test their rivals’ strength. In particular the Baltimore & Ohio was aggressive. “At the time of its [Chicago branch] opening,” said Mr. Blanchard before the Hepburn Committee, “it was heralded all over the Northwest as a ‘Relief for the Farmer,’ ‘the Grangers’ Friend,’ and all other sorts of headlines were put into the Chicago and Northwestern papers; and President Garrett’s public utterances, and those to his Board, were filled with enough statements to show what he intended to do.... I heard him [say] that upon the completion of his lines, like another Samson, he could pull down the temple of rates upon the heads of these other trunk lines.”5

Under these circumstances a dispute between the Baltimore & Ohio and the Pennsylvania in 1874 over the former’s connection with New York had far-reaching consequences.6 The Pennsylvania refused to carry Baltimore & Ohio cars over its line north from Philadelphia, and as a retaliatory measure the Baltimore & Ohio reduced passenger fares from Washington and Baltimore to Western points from 25 to 40 per cent.7 The reduction in rates thus begun inaugurated the first of the great railroad wars. The cuts soon extended to east-bound passengers and to freight, and forced corresponding cuts on the Pennsylvania, the Lake Shore & Michigan Southern, the Michigan Central, the New York Central, and the Erie. Rates on fourth class and grain from Chicago to New York, which had been 60 cents per 100 pounds in December, 1873, and 40 cents in December, 1874, fell to 30 cents in March, 1875. Rates on special, or sixth class,8 went as low as 12 cents from Baltimore and Philadelphia to Chicago. Passenger fares from Chicago to Baltimore and Washington were reduced from $19 to $9, to Philadelphia from $19 to $12, to New York from $22 to $15, and to Boston from $22 to $15. The New York Central and the Erie quoted fares from New York to Chicago of $18 and to St. Louis of $20, and the Baltimore & Ohio replied by a cut to $16.25 to Chicago. In April, 1875, the Baltimore & Ohio cut freight rates from Cumberland to Baltimore over 50 per cent on the four regular classes, and the Pennsylvania at once announced still greater reductions.9

The effect of this warfare on railroad revenues was sufficiently serious to cause the Baltimore & Ohio to recede somewhat from its independent position and to enter into negotiations with the Pennsylvania;10 but the terms of the resulting agreement proved unsatisfactory to the other trunk lines, and no general pacification was obtained. Late in 1875 rates nevertheless generally advanced, and in December a general agreement was concluded, followed by a general increase. This agreement was again hopelessly disrupted by the following April, when cuts in east-bound rates followed each other with rapidity. The published rates on grain, which had been 45 cents at the beginning of March, 1876, fell to 40 cents on March 7, 35 cents on April 13, 22½ cents on April 25, and 20 cents on May 5. In June rates on west-bound freight fell to 25 cents first class to Chicago, and 16 cents fourth and fifth class, actual rates going much lower; and it was possible to travel from New York to Chicago first class for $13.11

Warfare between railroads became intensified by the competition between the cities which the railroads served, and by 1876 the question of relative rates to New York, Philadelphia, and Baltimore had grown to be of primary importance.12 By an agreement in 1869 Baltimore had been given a differential on east-bound freight of 10 cents per 100 pounds, which had been reduced to 5 cents on grain in 1870. On west-bound freight Baltimore had enjoyed a differential in 1875 which had ranged from 10 cents on first class to 5 cents on special class freight, and Philadelphia one which had been 2 cents less except on first class, where the Philadelphia differential had been 3 cents less than that to Baltimore. A temporary agreement of March, 1876, had replaced these allowances by differentials of 13 per cent in favor of Baltimore and 10 per cent in favor of Philadelphia as against New York. This relation was fought over in the rate war of 1876. In December of that year another agreement was reached on the basis of equal rates from Western points to Europe on export traffic via all four competing seaboard cities, and reduced percentage differentials on local traffic to those cities; but this proved temporary, the subsequent advances in rates were not general, and final agreement was not secured until April, 1877. The contract then executed was in the nature of a compromise. The differential to Baltimore was reduced from 13 per cent to 3 cents, and from Philadelphia from 10 per cent to 2 cents, to apply equally to local and to export traffic. Rates to Boston were at no time to be less than those to New York. Differentials on west-bound traffic were to be the same as those on east-bound on third class, fourth class, and special freight, and on first and second classes to be 8 cents less per hundred from Baltimore and 6 cents less from Philadelphia than from New York.13

The years following the agreement of 1877 were marked by low and fluctuating rates, extensive cutting under the published schedules, and frequent attempts at pooling and at apportionment of traffic. At a meeting at Chicago on December 19, 1878, tariff rates were agreed upon by all lines, but the existence of time contracts depressed receipts for months thereafter. Another meeting on May 8 was followed by sharp competition. In June an agreement to raise rates was made, but proved unsatisfactory owing to long time contracts. “During the period between December 18, 1878, and July 5, 1879,” said Mr. King in a letter to the Trunk-Line Arbitrators on July 17, 1879, “the Baltimore & Ohio Company has practically been out of the market, on account of the low rates by the Northern lines. It has not secured enough east-bound freight to give return loads for the small west-bound traffic sent over its lines to that city, and has repeatedly moved its cars empty from Chicago to other points on its lines east of that city.”14

Early in 1881 the cutting of rates became sufficiently important to force official recognition by the chairman of the trunk-line pool.15 By June 17 quoted rates on grain were 15 cents per 100 pounds from Chicago to New York, and a railroad war was in full swing.16 By October the grain rate had been reduced from 15 cents to 12½ cents; by August passenger fares were $7 from New York to Chicago, and $16 from Chicago to New York, and there was quoted besides a $5 Boston to Chicago rate over the Grand Trunk. The radical nature of these cuts can be appreciated from Mr. Albert Fink’s testimony before the Hepburn and Cullom Committees. Fifteen cents, said he in 1879, just covered the actual cost of hauling the grain;17 twenty cents, he asserted in 1885, was the bare cost of movement, including the general expenses, but without any profit to the road.18 Grain was therefore not repaying the specific cost of hauling, and passengers were obviously in similar case. Temporary relief occurred through the large increase in business which took place at the end of 1881. In October the Pennsylvania and the Baltimore & Ohio advanced east-bound rates because of the abundance of traffic offering, and the New York Central, Erie, and Grand Trunk followed to a less degree. In November further advances occurred, though west-bound rates remained low; but throughout December and January rates were low and fluctuating,19 and negotiations were carried on for the settlement of the differential question which underlay the trouble. None of the combatants were open to conviction; the only outlet was therefore arbitration, and this was reluctantly resorted to.20 In January, 1882, the roads divided the through trunk-line business, agreed to raise rates, and left the subject of differentials to be investigated by Messrs. Thurman, Washburn, and Cooley.21

This solution settled nothing. During the following three years constant disputes arose over the proper division of traffic,22 and in 1884 the old struggle was resumed with unabated vigor. Rates on grain to the seaboard fell from 30 cents to 20 cents on March 14 of that year, and to 15 cents on March 21; remaining low and fluctuating through the year.23 Immigrant business from New York to Chicago was handled by the Pennsylvania at one dollar a head. By February, 1885, rates for traffic in both directions were completely demoralized. Nominal east-bound charges on grain were 25 cents, or a 10 cent advance since the preceding March, but actual rates were as low as 8 and 10 cents. Meanwhile published rates on west-bound freight were a third less than the standard tariff, and passenger rates in both directions were, roughly, one-half the regular charges. The following month still further reductions occurred. The warfare was finally terminated by an agreement to maintain rates late in 1885,24 followed by an elaborate pooling agreement between the competing lines.25

From 1875 to 1885 the trunk lines to the Atlantic ports were thus engaged in active competition. What was the effect of this upon the Baltimore & Ohio? This road was highly prosperous in 1875. Dividends of 6 per cent and 10 per cent were being paid. The capitalization was small, and the management conservative. During the ten years following 1875 the rate of dividend was not materially decreased. In 1876 10 per cent was paid. In 1877 the old 8 per cent rate was restored, and the following year the distribution was made in stock instead of in cash. After the agreement of 1878 one-half year’s dividend was paid in cash; and in 1879 9 per cent cash, and in 1880 10 per cent cash was declared, this rate enduring until 1886. But although dividends were maintained, the effect of the railroad wars appeared in the slowness with which net earnings increased. A comparison of the net returns of 1884 with those of 1874 reveals a gain of 40 per cent, on a mileage 27 per cent greater; but the figures for 1885 show an increase of less than 2 per cent over those for 1874, while the totals for 1884 were not again equalled until 1900. Meanwhile more bonds had been issued, and the percentage of fixed charges to net earnings had increased from 16 in 1874 to 63 in 1884. In other words, money was borrowed to put into the road which did little more than keep the net earnings from declining. In that same time the stock increased $2,900,000, and according to the profit and loss account $15,559,636 were put into the property, making a total of $55,743,092 (of this $37,197,696 were bonds); the only result of which was the building of 313 miles of line, and the securing of an increase in net earnings for 1884, which was swept away the following year.

In 1884 the elder Garrett died, and his son Robert was elected to succeed him. The old policy of independence and competition was continued, the objective point being now an entrance into New York. “When in 1885 the other trunk lines harmonized their differences, ...” said the Chronicle, “the Baltimore & Ohio ... pursued its policy of aggression.... The road must reach Philadelphia ... nay, must push ... on to New York.... Instead of seeking to avoid rivalry, its every effort seemed to encourage it. Rates were reduced, concessions made to shippers and travellers, the one idea apparently being to get traffic no matter what the cost.”26 The necessity of a secure New York connection had been impressed upon the company in the course of the rate wars. The first step was to be actual construction to Philadelphia, the second, construction or traffic agreements from Philadelphia to New York. Bonds were issued in April, 1883, for construction of a so-called Philadelphia branch from Baltimore to the northern boundary of Cecil County, Maryland,27 there to connect with the Baltimore & Philadelphia Railroad, which was being built through Delaware and Pennsylvania to Philadelphia. Entrance into Philadelphia was secured over the Schuylkill River East Side Railway, a corporation organized under the laws of Pennsylvania and doing business in the city only.28 The distance was approximately ninety-nine miles; the cost was later asserted to have been $20,000,000. Beyond Philadelphia the Baltimore & Ohio relied on an agreement with the Philadelphia & Reading for trackage to Bound Brook, New Jersey,29 and on a traffic contract with the Central of New Jersey for its line from Bound Brook to Elizabeth.30 Terminals on Staten Island were secured by purchase of a controlling interest in the Staten Island Rapid Transit Company,31 and connection between Elizabeth and the Island was obtained by new construction. The strength of this route was in its directness and in its independence of trunk-line control; its weakness was in its excessive cost between Baltimore and Philadelphia, and in its reliance upon traffic contracts north of the latter city. A proposition was advanced to unite the Baltimore & Ohio, the Philadelphia & Reading, and the Central of New Jersey with the Richmond Terminal System. This, however, fell through,32 and the possibility still existed that the Baltimore & Ohio might some day construct a line of its own from Philadelphia to New York.

Pending the completion of the preceding arrangements rate conditions remained naturally unsatisfactory. The Pennsylvania objected to the paralleling of its Philadelphia-New York branch, and refused to allow temporary use of that line by the Baltimore & Ohio while the latter’s independent connections were being established.33 Freight rates were slowly and painfully raised after the conflict of 1884–5, and did not regain a high level. In 1886 the Baltimore & Ohio was forced to reduce its dividends from 10 to 8 per cent. The following year it cut to 4 per cent, and in 1888 no dividend at all was declared. The surplus on the year’s operations, which had not since 1878 fallen below $1,000,000, dropped to $110,819 in 1885, and to $36,259 in 1886. As dividends decreased, the funded debt increased,34 the percentage of fixed charges to net income rose from 63 to 89, and the floating debt attained the portentous amount of $11,148,007. The only item which did not grow was net earnings. There was nothing occult in the situation. Every one was well aware that the competition to which the Baltimore & Ohio had been subjected had been severe, and that the cost of its New York extension had been large. In 1887 the bonds outstanding were $56,868,201, the stock $19,792,566, and the accumulated surplus $48,083,720, or a total of $124,744,487. This stood for the sums invested in the property. Net income on the other hand was $4,994,721; so that on an investment of over $100,000,000 but 4 per cent was being obtained to cover interest, improvements, and whatever dividend might be declared.

That no general apprehension was felt by investors before 1887 was due to the great prestige which the Baltimore & Ohio enjoyed. The long series of dividends counted heavily in favor of the road. The enormous accumulated surplus, said to have been invested in valuable improvements and extensions;35 the enterprise of the company in making extensions; the large volume of business; and the confident statements of the president, all conspired to prevent a too keen analysis of the business returns.36 Relief of two sorts was nevertheless required. In the first place the floating debt had grown so large that some means of paying it off was necessary; in the second place the road needed a sufficient reduction in fixed charges to restore some of the margin of non-mortgaged earnings which had been so great a safeguard in the early days. Only the first of these requirements was met. Cash the road had to have; the existing fixed charges, it was thought, it could endure if only some abatement of the intensity of trunk-line competition could be obtained.

The method chosen for raising cash was the sale of bonds. In September, 1887, J. P. Morgan & Co. announced that a preliminary contract had been entered into between the Baltimore & Ohio Railroad Company and J. S. Morgan & Co., Baring Bros. & Co., and Brown, Shipley & Co., of London, and their allied houses in America, for the negotiation of $5,000,000 Baltimore & Ohio Consolidated 5s and of $5,000,000 preferred stock, for the purpose of paying off the entire floating debt, and of placing the company upon a sound financial basis.37 The consolidated bonds were to be part of an authorized issue of $29,600,000, of which $21,423,000 were to be reserved to retire the main stem mortgage indebtedness when it should fall due, and $8,177,112 were to be exchanged for securities in the company’s sinking fund, the freed securities to be used to pay the floating debt in part. In case this exchange should not be made, $7,500,000 of the issue might be sold direct, and the syndicate before mentioned agreed to take $5,000,000 of this amount and to place $5,000,000 in preferred stock on condition:

(a) That the statements of the company should be verified;

(b) That the management of the company should be placed in competent hands, satisfactory to the syndicate;

(c) That satisfactory contracts should be made between the Baltimore & Ohio and other roads for New York business, which should remove all antagonism between them on the subject, and should ensure the permanent working of the first-named in entire harmony with the other trunk lines, besides avoiding the construction, or the threat of construction, of expensive lines north and east of Philadelphia.

Annual payments to the Baltimore & Ohio sinking funds were to be made in the future in consols instead of in cash.38

The essence of this arrangement was a funding of the floating debt, plus agreements with other roads in order to maintain earnings. The funding involved, however, a certain increase of charges through the issue of bonds, while the agreements offered but a doubtful chance of increased earnings. Only by an effective community of interest or of ownership among the trunk lines could a saving have been secured on which the new bond issues could safely have relied. That this was to take place through the syndicate, that body was emphatic in denying. “The statement,” said Vice-President Spencer, “that the Baltimore & Ohio Railroad has passed into the hands of a syndicate, of which J. P. Morgan is the head, is absolutely without foundation.... The syndicate has the greatest interest now in the growth of the Baltimore & Ohio, and to secure this growth and progress absolute independence of other corporate predominance is essential, and the road must be worked in the interest of the states and territories it reaches.”39 This declaration left only informal agreements as a resort; for pooling had been forbidden in 1887. It did more, it implied the necessity of a maintenance of competition, for to work the Baltimore & Ohio in the interest of Baltimore meant to work it against the interest of New York. In principle the plan was nevertheless adopted. Bondholders saw no necessity for a radical reorganization, and were willing to consent only to a new issue of bonds. Certain modifications were, however, imposed. The exchange of new bonds for securities in the sinking fund was abandoned, and the alternative of direct sale was embraced. It was found impossible to secure the consent of stockholders to an increase in the preferred stock, three attempts to obtain the required authorization failing in the week ending January 20, 1888.40 Furthermore, the failure of the stock issue led President Spencer41 to request that the city of Baltimore extend for five years at 4 per cent a $5,000,000 loan to the company, which was to mature in two years, and that it return the sinking fund of $2,400,000 which had accumulated in its hands for the eventual cancellation of the debt.42 It may be added that this suggestion was not accepted.

While awaiting final settlement of the syndicate scheme the Baltimore & Ohio obtained some cash from the disposal of all its free resources; that is, from the telegraph, express, and sleeping-car businesses which it had conducted since early in the administration of John Garrett. In August, 1887, it sold its express business to the United States Express Company for a period of thirty years, in return for $1,500,000 of the capital stock of the express company plus a certain percentage of the annual earnings of the express lines handed over.43 In October of the same year its telegraph business was turned over to the Western Union Telegraph Company in return for $5,000,000 of the Western Union stock, and an annual payment of $60,000 in cash.44 Finally, in June, 1888, its sleeping-car equipment and franchises were transferred to the Pullman Company for a period of twenty-five years at a reported price of $1,250,000.45 The company agreed to furnish all the sleeping and parlor cars required. This brought the incidental advantage of ending long-continued suits over patents. The terms of sale to the telegraph and express companies brought in no ready money, but the securities obtained were readily salable, and being independent for their value of the commercial success of the Baltimore & Ohio were available for times of difficulty. It was this policy which offset the refusal of the city of Baltimore to return the sinking fund to the company, and which by March, 1888, rendered the road even to some extent independent of the syndicate. At that date a modification of the syndicate agreement took place. The bankers gave up all claim to the $5,000,000 of stock so long under discussion, and took instead the balance ($2,500,000) of the $7,500,000 consolidated mortgage bonds which the company was authorized to sell. “The syndicate acted,” said the Baltimore Sun, “in an entirely friendly spirit, and, with a desire to continue its financial relations with the company, took the remaining $2,500,000 ... at a better price than was paid for the $5,000,000.”46

With temporary financial requirements provided for, President Spencer was enabled to achieve some much-needed reforms. At a meeting of the directors on March 14 a complete reorganization of the service was authorized, with changes and transfers affecting employees from the first vice-president down. Later a committee of mechanical experts was organized “to examine thoroughly all the shops, shop tools, etc., of the entire Baltimore & Ohio system, and to report on all the improvements needed.”47 The form of the annual report was improved. The much-quoted surplus, which had proved such an unreliable support, was cut in two by the writing off of bad investments, the marking down of the price of securities, and the like; and, finally, a committee was appointed to make a general examination of the financial as well as the physical condition of affairs.48 “Great anxiety,” said a resolution of the directors, “exists in the public mind as to the financial condition and the value and earning capacity of the road and property ... [and] it is due to all interests that a full, frank, and complete statement of its affairs should be made public.” So far as lay in his power President Spencer, and through him the syndicate, tried to secure a real and permanent improvement in the condition of the road, and to gain, through increased efficiency in operation, the margin which the refusal to cut down fixed charges had denied. The failure of the attempt may be ascribed to the continuance of the Garrett family in power. Any irregularities or mistakes which had taken place in the past reflected on the Garretts, so that it was to their interest to stifle investigation. Moreover, any change in policy for the future implied a criticism of their acts to which they were reluctant to accede. In 1888 the Garrett holdings amounted to from 50,000 to 60,000 shares out of a total of 150,000 shares, or, deducting 32,500 shares held by the city of Baltimore, which were not entitled to vote, to about one-half of a total of 117,500 shares. This gave undisputed control. The effect was seen in the annual election in November. Of 12 old members of the board only 5 were reëlected, and of the 7 dropped 3 formed part of the investigating committee engaged in securing “the full, frank, and complete statement of the company’s condition” promised at an earlier date.49 The same month President Spencer was ousted and Mr. Charles F. Mayer was elected in his place.

This revolution was fatal to any radical reform, so that during the next seven years the condition of the Baltimore & Ohio improved but little. Net income grew, it is true, up to the panic year of 1893, but fell so sharply after that that the reported figures for 1895 exceeded those of 1888 by but $1,283,843, and even this gain was practically wiped out during the following year. Meanwhile fixed charges grew from $6,550,972 in 1888 to $6,934,052 in 1895, and to $7,303,781 in 1896; an increase which transformed the profits of the company the following year into a deficit. A comparison of the balance-sheets of 1888 and 1895 shows an increase of $10,207,434 in stock, of $16,261,000 in funded debt, and of $4,554,939 in floating debt. These changes were offset mainly by increases in bonds and stock owned, or in the hands of trustees, by advances to subsidiary lines, and by a reduction of $11,080,000 in bonded debt secured by collateral or by mortgage on the main line. During this time dividends were nevertheless steadily paid on the preferred stock, and, beginning in 1891, upon the common stock as well. The liberal tendencies of the management were also evinced by a 20 per cent dividend upon the common stock, declared in 1891 to compensate shareholders for expenditures in betterments and improvements of the physical condition of the property.50 It will be seen how different this was from the policy of retrenchment and economy which had been inaugurated by President Spencer, and which might fairly have been expected from a corporation barely escaped from bankruptcy.

Traffic conditions from 1887 to 1893 were very far from satisfactory. The difficulties between the Baltimore & Ohio and the Pennsylvania were indeed patched up, and the opening of the former’s lines to New York rendered it independent of other trunk-line connections; but frequent charges of rate cutting were made in 1887, and a war in dressed-beef rates was inaugurated by the Grand Trunk in November of that year. In 1888 rates were pretty much demoralized. Published rates on grain dropped from 27½ cents in January to 20 cents in October. Emigrant rates from New York to western points became the subject of active competition; and, most important of all, the dressed-beef controversy was pushed till it developed into a war of the most active kind. The trouble here was started by cuts on dressed beef by the Grand Trunk. In May other lines retaliated by cuts in live-stock rates; by July 14 published rates on cattle from Chicago to New York were 5½ cents per 100 pounds, and on dressed beef and hogs 7 cents. In November the New York Central extended the contest by a general reduction in west-bound rates.51 These struggles, though terminated for a time by an agreement of February, 1889,52 seriously diminished railway revenues, and prevented the rapid growth which the general prosperity of the country might have occasioned.53 In fact, the Erie management stated in their annual report for 1888 that their company had retired altogether from certain classes of through business for a time during the preceding twelve months, owing to the unremunerative level of rates. Conditions during the greater part of 1889 were better,54 and during the following three years constant attempts at agreement and arbitration, joined with a considerable volume of business,55 prevented a long continuance of any difficulties which arose.

It was perhaps traffic conditions such as we have described which led the Garrett family to favor a community of interest scheme which should improve the Baltimore & Ohio connections with the West. In June, 1890, Mr. E. R. Bacon formed a syndicate to control the stock of the Baltimore & Ohio Company. Acting in harmony with the Garrett family, the syndicate was made up of Philadelphia, New York, Baltimore, and Pittsburg capitalists, including the Richmond Terminal, Pittsburgh & Western, Northern Pacific, and Reading interests. The plan was to establish a community of interest between a vast network of lines reaching from the Atlantic to the Pacific, and from New York to the Mississippi. “The buyers,” it was said, “came in simply as investors without condition that their other properties would be benefited, although it was of course intimated that something was to be done.”56 They were required to pool their stock for three years, and to give an irrevocable proxy for that period to President Charles F. Mayer. The amount of the syndicate purchase was 45,000 shares, of which 32,500 were obtained from the city of Baltimore, and 9686 (preferred) from the state of Maryland;57 and the purchase brought the incidental advantage of removing city and state from any direct interest in the road. The preferred state stock the syndicate later exchanged for common stock owned by the Johns Hopkins University. The purchase once made, the pool was formed on well-known lines. The stock was deposited with a trust company, trust certificates were issued, and proxies transferred to Charles F. Mayer.58 The shares to be deposited were limited in amount to 110,000; the actual amount put in was 89,750. The results of the agreement were less sensational than the forecasts made. It undoubtedly did much to promote friendly feeling among the roads concerned. When, in 1891, the Baltimore & Ohio was compelled to vacate the Chicago terminals of the Illinois Central, which it had occupied for years, it was able to make prompt arrangements with a corporation controlled by the Northern Pacific for the use of its facilities both for passengers and for freight. But the influence of the Garrett family was not lessened, and inasmuch as the main competitors of the Baltimore & Ohio were not included there was no check to competition, and earnings showed no striking change.

Matters stood thus at the beginning of 1893.59 No progress had been made toward restoring the Baltimore & Ohio to a permanently stable condition, and the prosperity which its reports declared was fictitious only. The reorganization to which bondholders had refused to submit in the comparatively prosperous times of 1888 was compelled by the depression following the panic of 1893. In 1894 earnings fell off. The gross earnings for the year ending June 30, 1893, were $26,214,807, and the net income $9,210,666; the following year the same items were $22,502,662 and $8,719,830. The directors reduced the dividend and called attention to the losses incurred through protracted strikes in the coal and coke industry.60 The following January (1895) President Mayer stated that the fixed charges, including the car trusts, sinking funds, etc., due January 1, amounting to nearly $1,000,000, had been paid without borrowing one dollar. “I name this fact especially,” said he, “because it is not unusual for us to make a loan for the unusually heavy payments January 1. I doubt if the Baltimore & Ohio has owed so small a floating debt for twelve or fifteen years, perhaps longer, and it never had the large volume of stocks and bonds it now has, something over $16,000,000, not put down at their face value but rather at their market value, or far below their intrinsic value. I can safely say the road has not been in so strong a position as now for at least fifteen years.”61

It required more than confident statements by the managers, however, to demonstrate the secure position of the road; and this all the more because the acts of these gentlemen belied their public assertions. Dividends on the common stock were passed in 1895, and again in 1896. The ratio of charges to earnings, according to the company’s reports, rose from 75 per cent of net earnings in 1894 to 80.2 per cent in 1895, and to 98.2 per cent in 1896; that is, less than 2 per cent of the net earnings of $6,300,000 was admitted to be available for dividends on $30,000,000 of stock.62 Some relief was evidently necessary. In January, 1896, it was announced that arrangements had been made with a strong syndicate to provide for all immediate financial requirements; but the appointment of receivers in February could scarcely have come as a surprise. During the two weeks just before the failure Mr. J. K. Cowen, who had succeeded Mr. Mayer in the presidency, spent a great deal of time in New York trying to borrow money to meet the pressing demands. On his eventual failure and return to Baltimore the directors felt that a friendly receivership was the only resource.63

To the well-wishers of the road this failure may have seemed an opportunity as well as a disaster. It was now possible to accomplish what the management in 1888 had refused to attempt, i. e. a reduction in the fixed charges of the company which should remove the burdens under which the road had labored, and should open up the way for a long period of improvement and prosperity. At least one more unpleasant experience was, however, to be passed through. With a view to determining the Baltimore & Ohio’s real position, an expert accountant, Mr. Stephen Little, had been set to work upon its books, and from time to time notices had been appearing that he was at work, that his examinations confirmed the statements of the company, and that questions raised by hostile critics would be considered in his report. Thus in April a reorganization committee, composed of Messrs. Alexander Shaw, C. Morton Stuart, and six others, with whom were deposited the Garrett shares, issued a circular referring to the large amount of new capital, estimated by them at $30,000,000, which had been received by the company since 1888 “without adequate or satisfactory results,” and to the floating debt, which they asserted had been increased from about $3,500,000 to $16,000,000. “We make no charges, or even intimations of wrongdoing,” wrote their secretary, “but desire and require that a full explanation of the management of the property from the year 1888, when the road was set on its feet by Mr. Morgan, shall be given, and that the causes which led to the wrecking of the property shall be clearly shown.” To which another committee, which directly represented the management, replied by reference to Mr. Little.64

The much-heralded report came out in December, having been withheld since the previous March for fear of the effect on the company’s securities; and so far from sustaining the management, it contained charges of irregularity almost as sensational as those made against the Atchison at an earlier date. The books of the company, according to Mr. Little, were in error to the amount of $11,204,858. During the period of seven years and two months which his report covered he found:

An overstatement of net income of

$2,721,068   

A mischarge of worn-out equipment to profit and loss of

2,843,596   

Improper capitalization of charges to income under the head of construction, main stem,

2,064,741   

Improper capitalization of so-called improvements and betterments of leased and dependent roads,

3,575,453   

Total,

$11,204,85865

Deducting these sums from the annual income returns of the company, he found that but $971,447 had been earned which had been properly applicable to dividends, whereas $6,269,008 had been declared in the seven years, of which $3,312,089 were cash and $2,956,920 stock. Earnings had been increased by the most arbitrary of book-keeping devices. In 1892 the value of the Western Union stock held in the treasury since the sale of the Baltimore & Ohio telegraph lines in 1888 had been written up $468,038, and the stock of another company, the Consolidated Coal Company, had been written up $114,300. Not only had advances to branch lines been entered as assets, but the interest on these advances had been credited to income, the only basis being that it was hoped that such interest would some day be paid; and on the other side of the account, charges against operating expenses had been charged to profit and loss on the same principles by which the Garretts had rolled up their fictitious surplus of 1888. Turning to the capital account, Mr. Little showed an increase in liabilities from 1888 to 1895 of $22,180,000, not including $5,481,835 representing chiefly the company’s endorsements of notes of its subsidiary roads which stood here for the first time revealed. This money apparently had been put into the property, and yet Mr. Little’s corrected figures showed net earnings to be actually smaller in 1895 than in the earlier years. Criticisms of the report attached themselves mainly to the last items treated. That the extensive endorsement of branch-line notes, absent as any mention of the practice was from the annual reports, was most misleading and unsound, nobody could deny; but the broad question of what charges during the seven years should have been paid out of income, and what not, gave rise to lively discussion. Severe strictures on Mr. Little’s statements were made by Patterson and Corwin, two accountants appointed to re-examine the books of the company. “It would appear,” said they, “that Mr. Little has made some curious errors, and has been strikingly inconsistent.”66 Nevertheless the more damaging of the latter’s accusations seem to have been accepted, and the Baltimore & Ohio took its place with other American corporations, the managements of which have indulged in secret juggling with the books.

Pending Mr. Little’s report, reorganization was of course delayed. The receivers were then in control,67 and under their direction a vigorous policy of improvement was carried out. The rolling stock of the system was found to be insufficient to handle its business, and the motive power was in similar condition. All testified to the consistent desire of the old management to employ every device which might contribute to greater apparent earnings. Contracts for 5000 freight cars were let as early as May, 1896, to be paid for in receivers’ certificates, and bids for 75 locomotives were at the same time received.68 During their whole administration the receivers purchased over 28,000 freight cars, 216 locomotives, 123,000 tons of rails, besides ties, ballast, new steel bridges, and miscellaneous improvements of various sorts.69 On the financial side they had to resist an attempt to compel payment of dividends on the preferred stock. The case dragged on through 1897 and 1898, and was finally decided in favor of the company.70

After the publication of Mr. Little’s report there remained no serious bar to reorganization, while the needs to be met were more apparent than ever before. If the proportion of charges to earnings had been too heavy on the management’s own showing, how much more burdensome was it when the reported earnings had been proved too high, and the reported liabilities too low! The first step after the appointment of receivers had been the springing up of reorganization committees. The two most prominent were the Fitzgerald Committee, representing the directors, and the Baltimore Committee. There were besides committees representing the 5 per cent bonds of the loan of 1885, the consolidated mortgage 5s, the 6 per cent bonds of 1874, the preferred stock, and others. These were all to some extent antagonistic. It was hoped to secure a reorganization without foreclosure, but to provide against all contingencies a bill was introduced and passed through the Maryland legislature, permitting a new company to succeed, after reorganization, to the property of the Baltimore & Ohio system.

By April, 1898, a reorganization plan was ready, and was withheld only on account, first of the threatened, and then of the actual, war with Spain. Two months later this difficulty seemed no longer serious, and a plan was formally announced.71 There were contemplated two great issues of bonds and two of stock as follows:

3½ per cent prior lien gold bonds,

$70,000,000

4 per cent first mortgage gold bonds,

50,000,000

4 per cent non-cumulative preferred stock,

35,000,000

Common stock,

35,000,000

These were to be parts of larger amounts authorized but not issued. Thus the authorized amount of prior liens was $75,000,000, of which $5,000,000 were to be reserved, and to be issued after January 1, 1902, at the rate of not exceeding $1,000,000 a year, for enlargement, betterment, or extension of properties covered by the prior lien mortgage; or for the acquisition of additions thereto.72 The authorized amount of first mortgage 4s was $165,000,000. Since the prior liens matured in 1925, and this mortgage not till 1948, $75,000,000 were reserved for retirement of the prior issue. $7,000,000 were further put aside for the new company; $6,000,000 for the retirement of the Baltimore Belt Line 5s, and $27,000,000 for enlargements, betterments, or extensions, etc., at a rate not exceeding $1,500,000 a year for four years, and not exceeding $1,000,000 a year thereafter.73 The reserves from these two mortgages, therefore, made liberal provision for new capital requirements. All of the common stock authorized was to be issued at once; but besides the $35,000,000 preferred stock before mentioned, $5,000,000 preferred were to be held in reserve for the new company.

Of the immediate issues $60,073,090 prior liens, $36,384,535 first mortgage 4s, $17,218,700 preferred stock, and $31,178,000 common stock went toward the retirement of old securities; and $9,000,000 prior liens, $12,450,000 first mortgage 4s, and $16,450,000 preferred stock were for cash requirements. The better of the old mortgages received cash for their overdue interest, something over par in prior liens for their principal, and from 12½ to 32 per cent in first mortgage 4s and preferred stock to compensate for reductions in their annual return. Inferior bonds received new first mortgage 4s with preferred stock (except in one instance) as a douceur. The old stock, common and preferred, and the Washington City & Point Lookout 6s got mostly new stock for the principal of their holdings, and preferred stock for their assessments. The fundamental principle on which the exchanges were based was the retirement of old bonds bearing high interest rates by an increased volume of new bonds bearing lower rates; thus permitting a much smaller reduction in fixed charges than occurred in other reorganizations which we shall consider. To some extent reductions in annual yield were made up by allowance of preferred stock. The consolidated mortgage 5s of 1887, on which interest was reduced from $50 annually to $41.75, received $85 in 4 per cent preferred stock as a compensation. The Baltimore & Ohio Loan of 1874 saw a reduction in interest from $60 to $40.41, partially made up from the dividends on $160 of new preferred stock. In fact, out of thirteen cases in which new bonds were given for old, ten included an allowance of preferred stock, thus bringing the Baltimore & Ohio in line with other reorganizations of the period. But the proportion of preferred stock given was small in each case, and the principle was not well carried out.74

The cash requirements of the system were estimated at $36,092,500; being swelled by arrears of interest, receivers’ certificates, need for working capital, reorganization expenditures, and the like. The plan proposed to cancel them by assessments on stockholders and by the sale of securities before described. On the first preferred stock, $2 a share was levied, $20 on the second preferred, and $20 on the common stock, with a syndicate guarantee for each. This netted $5,460,000. Stockholders received new preferred stock for their payments. Deducting $5,460,000 preferred stock from the securities reserved under the plan to be sold for cash, there remained $9,000,000 prior liens, $12,450,000 first mortgage 4s, and $10,990,000 preferred stock, or a total of $32,440,000; all of which a syndicate agreed to take.75 In addition the company disposed of securities in the treasury, including $3,800,000 stock of the Western Union Telegraph Company, for $3,500,000.76

Both classes of stock were vested in five voting trustees, for a period of five years. The trustees might, however, deliver the stock at an earlier date in their discretion, and in fact did so in August, 1901. No additional mortgage was to be put upon the property, and no increase in the amount of the preferred stock was to be made, except in each instance after obtaining the consent of the holders of a majority of the whole amount of preferred stock outstanding, given at a meeting of the stockholders called for that purpose, and the consent of the holders of a majority of such part of the common stock as should be represented at such meeting, the holders of each class of stock voting separately. During the existence of the voting trust similar consent of holders of like amounts of the respective classes of trust certificates was to be necessary for the purposes indicated. Only a portion of the leased and dependent lines were provided for in the plan, but the various cases were left to be passed on separately. Thus the Baltimore Belt Line was finally leased at a rental equivalent to 4 per cent on the outstanding 5 per cent bonds; while the acquisition of the Baltimore & Ohio Southwestern and the Central Ohio railroads involved the payment of a cash bonus, and an increase in the preferred and common stock outstanding. The mileage of the system suffered little change. Many of the branches were sold at foreclosure, and bought in by the parent line; and a glance at the balance-sheet in 1899 shows that besides the prior liens and the first 4s, an issue of Pittsburg Junction and Middle Division bonds was the principal tool employed. These securities, bearing 3½ per cent, and falling due in 1925, were issued; 1st, to retire branch-line securities, and to weld the system into one united whole; and 2d, to provide new capital for enlargement and betterment and extension.

The success of this Baltimore & Ohio reorganization plan was very largely due to the time at which it was put through. In other words, the reorganization was completed just when an unparalleled era of prosperity was fairly under way. The moderate reduction in fixed charges which it secured proved more than adequate when earnings rapidly grew. The net earnings of the property for the year ending June 30, 1898, were estimated at $7,724,758, and the new fixed charges were set at $6,252,351.77 Net earnings for 1899 were $6,621,599. In 1900, on a mileage 11 per cent greater, they were $12,359,443, and fixed charges were $6,831,463 only. In subsequent years, with an increase both in mileage and in earnings, the margin between charges and income further increased. In 1903 $3,500,000 were spent out of earnings for additions and improvements; $7,370,482 were declared in dividends; and $2,947,681 were carried to surplus. In 1907 $3,000,000 were spent in additions and improvements, $6,965,245 paid in dividends, $7,480,385 carried to surplus. This situation was in no way due to the reorganization plan, and would have restored the company to solvency even if no reorganization had taken place. It may be said that the receivership did much to enable the road to take advantage of the later prosperity. The character of the receivers’ work has been mentioned. By June 30, 1899, they had spent as much as $17,000,000 for cars alone, $2,500,000 for locomotives, $2,100,000 for rails, and other sums for improvements and renewals of all kinds. The maintenance of way pay-rolls in three years amounted to nearly $12,000,000, and the total expenditure aggregated about $35,000,000; of which $15,000,000 were secured by the issue of receivers’ certificates, and the balance through car trusts, earnings from the property, and from the reorganization managers.78 This was an indispensable and invaluable preliminary to a growth in earnings, but was, however, distinct from the financial problems of reorganization. In brief, the Baltimore & Ohio increased its nominal capitalization more, and reduced its fixed charges less than any of the seven other reorganizations of the nineties which we shall consider except the Erie. Its need was perhaps less crying, but not sufficiently so to explain the difference.

It will be remembered that, while provision had early been made for foreclosure, it had been hoped to avoid such a drastic step. Hopes in this respect were fulfilled, and while a number of branch lines were sold the main stem escaped. Vigorous objections to the plan came from the preferred stock, which was in 1898 suing to compel payment of its dividends. In July, at a meeting of shareholders it was declared to be the sense of the meeting that the preferred stock could not justly be required to determine whether it would accept the proposition published by the reorganization committee before the case in the Supreme Court should be decided.79 Late in July an injunction was obtained, which, however, was dissolved in October. Still later in that year the suits were settled by the sale of the bulk of the first preferred stock to the reorganization committee.80 The only other considerable complaint came from the holders of the 4½ per cent Baltimore & Ohio Terminal bonds, and was a protest against the reduction of ½ per cent in their interest without, as they said, the smallest compensation. Suits for the foreclosure of the mortgages of 1887, 1872, and 1874 were instituted in October, 1898. Decrees were obtained in February. Decrees were also given against the Philadelphia Division, the Parkersburg Branch, the Staten Island Rapid Transit Company, and others. Separate receivers had previously been appointed for the Sandusky, Mansfield & Newark, the Central Ohio, the Washington Branch, and others. Decrees were not asked for against the main line. In August, 1898, only three months after the publication of the plan, the reorganization managers were able to pronounce it effective.

The receivers surrendered control July 1, 1899,81 and the company started on its new career amid a buzz of satisfaction from all who had participated in its reorganization. In an address before the Maryland Bar Association Mr. John K. Cowen summarized the result as follows:

(1) Every bondholder of the Baltimore & Ohio Railroad has received new securities which substantially pay his full debt. In other words, the bondholders have been paid in full.

(2) The floating debt creditors have received every cent of their indebtedness.

(3) The first preferred stockholders have received in cash 75 per cent of the par value of their stock, the court overruling their claim of preference over the bondholders and creditors. The second preferred stockholders have received securities which, after payment of the assessment, net about $70 per share, at the market price, and at times over $80 net could have been realized.

(4) The common stockholders, instead of being wiped out, have received their common stock in the new company upon paying an assessment, the net amount of which (because of the value of the securities received for such assessment) would not exceed $5 or $6.

(5) The company saves its old charter for whatever value may be attached to it.82

This statement presents the favorable side of the picture. On the whole, securityholders were tenderly handled, though the bondholders were by no means paid off in full. And on the other hand, this very tenderness made a voluntary reorganization possible, whereby the charter of the company was saved. The pertinent objections were from the point of view of the company itself, and these were silenced by the increase in earnings.

Since reorganization the Baltimore & Ohio has been enjoying great prosperity. On a mileage operated, which was some 1800 miles greater in 1907 than in 1900,83 it earned a return increased by over $40,000,000; while its income from dividends and interest mounted from less than half a million to over $3,000,000. Ton mileage figures were about 11,300,000,000 in 1907 as against 6,800,000,000 in 1900; passenger mileage had grown from 459,000,000 to 723,000,000. This prosperity has but reflected the condition of the country at large, but the Baltimore & Ohio has taken advantage of it in far-sighted fashion. No less than $17,000,000 have been spent from earnings for additions and improvements between June 30, 1899, and June 30, 1907, not to mention maintenance of way expenditures which have ranged from about $1500 to over $2500 per mile of road operated. Besides the provision made by the reorganization plan, $15,000,000 convertible debentures were issued under date of March 1, 1901, for new construction and improvements. There were authorized $40,000,000 of common stock in November, 1901, to go in part for improvements, and the bulk of $27,750,000 new common stock of 1906 will be applied to similar ends. As a result the company’s equipment has largely increased, grades have been reduced, curves straightened, light rails replaced by heavy, and subsidiary track increased. There were two miles of second, third, and fourth track and sidings for every three miles of main track in 1900; there were three miles to every four in 1907. A considerable increase in average freight train load has accordingly occurred. In 1900 the average load was 366 tons; in 1907 it was 433.02. That this figure has not still more greatly increased from the 406.53 tons of 1901 is probably due to the somewhat greater proportion of manufactures handled and to a considerable decrease in average distance hauled, and is compensated for by an increase of over one cent in the average rate received.

The events of most vital importance in the Baltimore & Ohio’s recent history have been connected with its control. In September, 1898, Philip D. Armour, Marshall Field, and Norman D. Ream, executors of the Pullman estate, together with James J. Hill of the Great Northern, bought a large interest in the stock, though whether or not sufficient to control no one knew. From statements by Mr. Cowen it would appear that the deal was somewhat similar to the earlier one in which the Northern Pacific had been interested: that is, it involved the sale of Baltimore & Ohio stock to secure the good will of men strong enough to support the road in case of difficulty, and influential enough to open desirable connections or to modify the stringency of competition. “The recent transaction,” said Mr. Cowen, “has been the realization of my hopes about the future of the road.” It was not Mr. Hill’s influence, however, that was destined to be dominant. By the end of the year rumors connected the Pennsylvania with the purchase of an interest in the property, and the election of Mr. S. M. Prevost, third vice-president of that company, to a directorship, gave assurance of the truth of the reports. It was, of course, impossible to purchase actual control so long as the Baltimore & Ohio stock remained in trust; but the trustees seemed very ready to accord to new buyers that representation and influence to which their stock might give them claim. At the annual election in November, 1900, an additional representative of the Pennsylvania was elected to the board, showing the probable increase of the Pennsylvania holdings, and the following year an absolute majority was said to have been passed, the shares held by Mr. Hill and his associates, and apparently sold to the Pennsylvania, being thought to contribute powerfully to that result.84 In May, Mr. Hill and Mr. Charles H. Tweed, chairman of the Southern Pacific, resigned from the directorate, to be replaced by two further representatives of the Pennsylvania. In June, President Cowen was replaced by Mr. S. F. Loree, fourth vice-president of the Pennsylvania lines west of Pittsburg, and in August the voting trust was dissolved.

The last step has been the sale of part of the Pennsylvania holdings to the Union Pacific system. It appears that the former’s interest in the company was largely due to anxiety over the coal situation. Before 1895 rates on bituminous coal had been depressed and demoralized. Rebates had been freely given in spite of any agreements which could be arranged. Under these circumstances the Pennsylvania had determined to buy enough stock of the Chesapeake & Ohio, the Baltimore & Ohio, and the Norfolk & Western companies to control the policies of these roads, and, through stock ownership in the Reading by the Baltimore & Ohio, to influence that company also.85 Unfortunately for the project public attention became concentrated on the coal industry at this time because of the discovery of certain flagrant abuses, and it seemed wise for the Pennsylvania to dispossess itself of a part of its stock.86 The Union Pacific was in the market with large resources derived from its sale of Great Northern and Northern Pacific stock. It was out of the question for the Pennsylvania to sell its shares to a competitor, but there was less objection to a sale to Mr. Harriman, providing a reasonable portion should be retained. Accordingly, the Pennsylvania sold and the Union Pacific interests bought, in October, 1906, some $39,540,600 in Baltimore & Ohio common and preferred stock, being in the neighborhood of half of the former’s holdings. This is the present situation of the property. The Baltimore & Ohio is independent, in the sense that it is not controlled by any single interest, but large amounts of its stock are owned by its competitor, the Pennsylvania, and by its connection, the Harriman system. On the whole the alliance with these interests augurs well for the future of the company.87

CHAPTER II
ERIE

Early history—Reorganization—Wall Street struggles—Financial difficulties—Second reorganization—Development of coal business—Extension to Chicago—Grant & Ward—Financial readjustment—New York, Pennsylvania & Ohio—Third reorganization—Later history.

The New York & Erie Railroad was organized in 1833 in the hope of bringing to the southern tier of counties in New York State a prosperity equal to that which the Erie Canal had secured for the northern tier. It was to run from New York or some suitable point in its vicinity to Lake Erie. A six foot gauge was adopted, partly because the grades encountered were thought to require locomotives with more power than a narrower gauge could accommodate, and partly because it was wished to make the road independent of any connection which might lead trade away from the city of New York.88

The events of the early years may be briefly dealt with. Difficulty was experienced in getting subscriptions, and in 1836 the legislature granted a loan of $3,000,000. An assignment was made in 1842, due to the difficulty of getting the enterprise under way, which resulted in the release of the company from liability to the state on condition that it complete its line from the Hudson to Lake Erie by 1851. Stockholders were to exchange two shares of old for one share of new stock, and a first mortgage of $3,000,000 was authorized.89 In 1851 the line was completed to Dunkirk on Lake Erie, and the following year it reported a bonded indebtedness of $14,000,000, capital stock of $6,000,000, and floating debt to the amount of $3,080,000, or a total of $43,961 per mile of line; a high figure, but probably necessarily so in view of the difficult work to be performed. Although nominally completed, the troubles of the road were not over; and a precarious existence was maintained only by the placing of additional loans in 1852 and 1855, and by the aid of Daniel Drew on two distinct occasions. A war of rates with the New York Central aggravated the situation; heavy storms and ice floods in January, 1857, caused serious loss, and the panic of that year, with the ensuing depression, proved more than the road could stand. Proceedings were begun in 1859 by the trustees of the fourth mortgage, and in August a receiver was appointed.90 The wonder was that such action had been delayed so long. The income of the road had been so far short of meeting current expenses that claims for labor, supplies, rents, and unpaid taxes, and judgments rendered against the company before the receivers were appointed, had mounted up to $741,510; while not only had interest on three mortgages fallen due in April, May, and June, but the principal of the second mortgage, amounting to $4,000,000, had matured. The settlement of claims and the reorganization of the company were put in the hands of J. C. Bancroft Davis and Dudley S. Gregory. Since the earnings of the road were at so low an ebb, wisdom would have seemed to dictate some scaling of the charges to correspond. This did not enter into the views of the trustees; instead, they proposed to give preferred stock for all unsecured indebtedness, to extend the principal of the second mortgage coming due, to exchange old common stock for new, to levy an assessment of 2½ per cent on both classes of new stock, and with the proceeds of the assessment to pay all coupons in arrears. Provision was made for the retirement of certain fourth mortgage bonds, and for a sale under foreclosure of that mortgage. By the arrangement no saving in fixed charges worth mentioning was secured; no sacrifice was demanded of bondholders; and, save for the payment of assessments and the (new) stock given for floating debt, the stockholder’s position was not made worse. The scheme was an easy and temporary means of escape from an embarrassing position. Before the reorganization the bonds outstanding had amounted to $18,006,000, the stock to $11,000,000, and the unsecured indebtedness to $8,504,000. After reorganization the totals were: indebtedness, $17,953,000, and stock, $19,911,000 (of which $8,911,000 preferred); or a capitalization of $67,728 per mile. The road was sold in 1862, and the Erie Railway took the place of the original New York & Erie Railroad Company.

With 1864 began the career of the Erie as a speculative Wall Street stock. Its large capitalization and the painful slowness with which its earnings grew kept the quotations of its shares normally at a low figure and invited speculation; while the location of its lines tempted more serious efforts to obtain control. Up to 1867 Daniel Drew was in power, while Commodore Vanderbilt spent his best efforts to drive him out; after that date Jay Gould and Jim Fisk became more and more prominent, and manipulated the Erie securities with enthusiastic regard to profits which they might derive both from the Erie Company itself and from operators who wished to speculate in its stock. In the course of the abundant litigation to which Gould’s methods gave rise, various receivers were appointed; but the orders of appointment were subsequently vacated, and the receiverships were nominal only. The details of the Wall Street struggles have little interest for us here.91 But the result is of importance. In the eight years from 1864 to 1872, when Gould was turned out of Erie by General Sickles and his English backers, the bonded indebtedness of the company increased from $17,822,900 to $26,395,000, and the common stock from $24,228,800 to $78,000,000; in the one case a growth of 48 per cent and in the other of 221 per cent, at a time when the mileage increased 53 per cent and the net earnings but 22 per cent.92 No more disgraceful record exists for any American railroad. The stock was not issued for the sake of improving the road, and it was subsequently shown that the road was not improved; but it was thrown upon the market at critical times in support of bear operations by the Erie managers, while portions of it, on at least one occasion, were bought back with the funds of the company to aid speculation for a rise. The result was to ruin the credit of the Erie, and to make it the favorite tool of cliques of gamblers. The increase in bonds occasioned an unmistakable increase in fixed charges, which rose from 20 per cent of gross earnings in 1864 to 25 per cent in 1871, 21 per cent in 1872, and 30 per cent in 1873, while the purchase of worthless bonds of subsidiary roads, such as the Boston, Hartford & Erie, lessened the assets without disclosing the real position to the casual observer.

In 1872 the control of Erie was taken from Gould through a vigorous campaign managed by General Daniel E. Sickles, and an “eminently respectable” board of directors was elected. Temporary relief was obtained from the use of $6,000,000, available from an issue of bonds previously approved,93 and dividends, first on the preferred and then on both preferred and common stock were declared. Unfortunately the dividends were not earned; and this fact, which was suspected from the previous record of the company and the marvel of its so early restoration to a dividend basis, was shown in the statements of ex-Auditor S. H. Dunan, who resigned in March, 1874, alleging that the accounts had been falsified to suit the company’s purposes, and that he was unwilling any longer to be a party thereto.94 Investigations conducted by representatives of English bondholders showed that in the three years ending in September, 1875, the profits of the road had been $1,008,775 instead of $5,352,673 as stated in the company’s accounts; and the severity of this finding was scarcely mitigated by the conclusion that in the opinion of the committee the dividends on the preferred stock at least were justified by the books.95 At the same time the report of Captain Tyler, another English representative, laid emphasis on the necessity for a change of gauge, a double track, improvements in gradient, fresh extensions and connections, and other similar matters.

The real position of the company at the time was shown but too well by the frequency of strikes upon its road. Thus in February, 1874, a strike of freight brakemen on the Susquehanna division broke out, caused principally by an order to discharge one of the brakemen from each freight crew, leaving only three on a train; and at the same time there was a strike of the switchmen on some of the divisions owing to a decrease in pay. In March occurred a serious strike among the employees of the road in Buffalo, mainly on account of irregularity and delay in payment of wages, and, finally, in April, there was trouble both in the Susquehanna shops and in the Jersey City freight yard over this same cause. The indications afforded by these troubles were borne out by the figures of the annual reports. The gross earnings of 1874 were $1,413,708 less than those of 1873, while the decrease in operating expenses was so slight as to reduce net earnings by nearly the same amount. If, now, there is deducted from the net earnings of the years 1871–3, inclusive, the sum which the London accountants declared to have been improperly reported as profits, there results an average of $4,175,699 net; or less than the net earnings for either 1864, 1865, or 1866, although the average charges for the years mentioned exceeded the average of the earlier period by $1,769,060 each year. These figures exclude the influence of the panic of 1873, which, as has been seen, caused a still further falling off in the earnings of the company. It was a time, moreover, when the Erie could not be content to sit still and wait, for competition was daily becoming more severe. By 1874 the Baltimore & Ohio, the New York Central, and the Pennsylvania had connections with Chicago, and the Erie was competing with them for business by means of traffic agreements with connecting lines. The next decade was to see the bitterest rate wars that the country has ever known; and the Erie, with its exceptional gauge and single track, was to compete with rivals of normal gauge, who were adding third and fourth tracks to the two which they already possessed. The one bright spot was the development of the coal traffic, which in 1874 formed the greatest item of the Erie’s tonnage, and was in a measure apart from the competition of other lines.

Suit was brought in July, 1874, for the appointment of a receiver. The complaint reviewed alleged improper acts of the management in declaring dividends, in buying Buffalo, New York & Erie stock and sundry coal lands, and in issuing the new $30,000,000 mortgage before mentioned.96 In October the Attorney-General of New York instituted suit on nominally the same grounds; not, as he explained, in the expectation that the appointment of a receiver would be required, but in order that this action might be taken if the conduct of the directors should make it necessary. Still other suits were begun before the year was out.

Meanwhile the management was changed. Whether or not Mr. Watson, who had been president since 1872, had done all humanly possible to set the Erie on its feet, his administration was not unnaturally in bad odor after the charges of Dunan and the report of the London accountants, to say nothing of the admittedly low earnings for the year 1874. An attempt was made to secure the very best man possible for the presidency, and to support him in necessary reforms, in the hope of some different results from those with which securityholders had become familiar. The man for the place was thought to be Mr. H. J. Jewett, a railroad man then in Congress from Ohio; and this gentleman was accordingly secured at an extremely liberal salary. Soon after his election a ten per cent cut in salaries was decreed, and an examination of the accounts of the stations along the line in behalf of the company was begun. It was too late, however, for the company. The business of the last of 1874 and first of 1875 was poor; floods in the spring damaged the property of the road, and rumors of a receivership were rife. On May 22 a private meeting of stockholders in New York passed resolutions to the effect that the borrowing of money by the sale of 7 per cent bonds at 40 cents on the dollar, and other means adopted by the Watson administration, would inevitably result in bankruptcy; that sound interest required that the money needed to pay interest should be raised by an assessment on the stockholders, and that the directors should be thereby requested to open books to examination, and to invite stockholders to contribute voluntarily a sum sufficient to keep the company from immediate failure.97 The proposal showed a proper spirit, but was impracticable. Four days later Mr. Jewett was appointed receiver on application of representatives of the Attorney-General and of the Railroad.98

This was the second receivership which the Erie had had to face, and the situation was materially worse than at the previous failure. According to the statement of President Jewett the funded indebtedness in May, 1875, amounted to $54,394,100, and the fixed charges to $5,059,828; while the net earnings for the previous nine months had decreased 13.4 per cent from the corresponding period for the previous year, and a serious deficit was in view. Temporary measures of relief had served but to drag the company further into the mire;99 and, most important of all, the causes for the existing difficulties were of a permanent nature, so that the future gave promise of still harder conditions than had existed in the past. What was needed was a reorganization which should undo the evil work of Gould, Fisk, Drew, and their associates, and which should secure the margin of surplus earnings which the reorganization of 1859–62 had failed to provide. Perhaps the chief difficulty lay in the fact that the men who were responsible for the increased capitalization were not at all those on whom the brunt of reconstruction would fall; for while the managers of the road had been Americans, the gullible investors had been Englishmen; and it was reported that much of the watered stock of the Gould régime had been unloaded on the English market.

Committees sprang up promptly. The most important of them were the English committees of bond- and stockholders, soon consolidated under the chairmanship of Sir Edward Watkin. On August 7, Sir Edward left England on a visit of inspection, accompanied by Mr. Morris, counsel for the bondholders. Conference with the board of directors and with President Jewett followed, and a provisional scheme of adjustment was decided upon. In his report to his English constituents Sir Edward outlined the results. Current indebtedness, said he, was $42,180,075; estimated net revenues for the year ending in June last were $3,715,609; operating expenses had been for that year 79 per cent, due largely to the cost imposed by exceptional gauge, while the chief lines with which the Erie competed showed proportions of only from 60 to 66 per cent. Out of fourteen branches only three showed a profit above rentals, and pay-rolls had ordinarily been months in arrears. These facts were familiar; the remedy proposed was unfortunately familiar as well. “Let it be hoped,” said this English financier, “that the bond- and stockholders will have the courage now to submit to a period of self-denial, and will consent to pay their debts and complete essential obligations out of available net profits, the bondholders receiving in place of cash such equitable obligations, realized out of surplus revenue in the future, as each, according to right of priority, may justly expect.”100 What could this have meant save an issue of stock or income bonds for coupons falling due, with the result of adding to the unwieldy capitalization of the road instead of reducing it as should have been done! For the rest, Sir Edward Watkin concluded with Mr. Jewett the following arrangement:

(1) Three nominees of the bond- and stockholders’ committee proposed by Watkin were to take seats in the Erie board;

(2) Mr. Morris was to be associated with counsel for the receiver and for the company, and was to be regarded and treated as one of the professional agents and officers of the undertaking;

(3) Mr. Jewett was to transmit a memorandum of his views on reorganization;

(4) Net earnings were to be retained for a while, and bondholders were to have a voice in their expenditure. Thus a vote was to be taken under the charge of the stock- and bondholders’ committee in London on the constitution of a committee of consultation, consisting of representatives of each class of bondholders and of preferred and ordinary stock, and that committee was to designate a special representative whose consent and approval were to be taken by Mr. Jewett in the expenditure of net earnings;

(5) Monthly reports of actual earnings and expenditures, together with reports from the president and receiver, were to be regularly transmitted to the office of the committee in London;

(6) Bond- and stockholders were to be urged to give power of attorney and proxies to Watkin, or to such other person or persons as the above representatives of the bond- and stockholders should designate;

(7) Any scheme of reorganization was to include a provision giving bondholders a voting power.

On the above resolutions Jewett, with his board, and Watkin, with his committee, agreed to coöperate.101 Under the circumstances the increased power given the bondholders was both a natural and a just demand, and it is probable that Mr. Jewett’s prompt acquiescence in it had something to do with Sir Edward’s advice to the securityholders “to rely on the honor, as I feel you may also upon the anxious labors and full experience of the President and Receiver.”

The report did not go uncriticised. It was pointed out, first, that a majority of English proprietors could not unhesitatingly share the confidence expressed in Mr. Jewett; second, that the first mortgage bondholders were well secured, and would surely refuse to fund their indebtedness; and third, that the payment of the floating debt, according to the Watkin plan, would simply create another debt of equal or greater amount due to the bondholders whose coupons were not paid. The only sound way, said a committee of bondholders in Dundee in a letter to the Watkin Committee, is resolutely to shun an accumulation of mortgage liabilities on the one hand, and on the other to give increased reality to the bonds and stocks of the company already existing as items in capital account, i. e. an assessment on the stock and a sweeping reduction in the interest on the bonds secured by the second mortgage:—the first mortgage bonds are in different case—they represent investment of cash instead of mere water, and even if foreclosure is difficult, they have beyond question an absolutely good security for the ultimate payment of both principal and interest.102

In September, 1875, a plan of reorganization was anonymously put forward as follows: Instead of assessment on the shareholders, it suggested the issue of 50 per cent more common stock; one new share for every two shares then existing. If a price of $25 per share could be obtained a total of $10,000,000 cash would be thereby secured. Besides the new stock issued bond- and preference-holders were to capitalize their interest for two years in bonds or shares bearing their present priorities. This funding should yield $8,000,000; and the $18,000,000 in all obtained was to be expended on the road over the next two years, during which period the new shares were to be paid up by half-yearly instalments. With the line furnished and equipped as proposed, continued this optimistic plan, the working expenses could be reduced from 79 per cent to 60 per cent, and the traffic within three years would be at least $24,000,000 per year, affording a net revenue of $9,600,000 per annum, sufficient to meet all bond and preference liabilities and to leave 3 per cent for the ordinary charges.103 The all sufficient criticism to this plan was that it required too great a combination of favorable circumstances to ensure its success. In some respects, however, it was not unlike the plan ultimately adopted.

Two months later appeared a plan by Mr. John C. Conybeare, an English bondholder, which was superior to the foregoing in that it proposed an assessment, and made some slight provision for an ultimate reduction in fixed charges. Mr. Conybeare proposed to assess preferred stock $11 and common stock $9. Payment of the assessment was not to be compulsory, but was to have the effect of giving to the stock which did pay a right to dividends before anything should be received by that which did not pay. Shares of the company by the plan would thus have ranked as follows:

(1) Preferred shares on which assessment had been paid, entitled to 7 per cent dividends before any other dividends were paid.

(2) Preferred shares on which no assessment had been paid, with rights inferior to the preferred A shares, but superior to the common shares.

(3) Common stock on which assessment had been paid, entitled to 4 per cent before further dividend on the common.

(4) Unprivileged, unassessed common stock which was to take what there was left.

In addition there was to be a pre-preference 8 per cent stock, ranking before all the above, which was to be issued to exchange in part for second preferred and convertible bonds. First consolidated bonds and sterling bonds of 1865 were to accept one or two per cent of their 7 per cent interest in bonds, secured perhaps by the coal property of the company, while the second consolidated and the convertible gold bonds were to receive 4 per cent in gold and 3 per cent in the new pre-preference stock as above. To the obvious possibility that the stockholders would refuse to pay an assessment the plan opposed no remedy. In this case the very moderate amount of interest funded would have been the only relief secured.104

These plans were, however, but preliminary to the elaborate Watkin scheme which appeared in December. The most prominent feature herein was, as previously indicated, the funding of coupons, both those past due and those to become due for a time into the future. Given net earnings sufficient to meet fixed charges, the postponement of interest by this plan would obviously have released revenue with which to make needed improvements on the road. This funding was to be, however, limited to the first consolidated 7s, convertible sterling 6s, second consolidated 7s, and convertible gold 7s; the six earlier issues were to be left untouched. One permanent reduction was also to be made, in that for the second mortgage and convertible 7s were to be given two classes of ninety-year gold bonds: the first for 60 per cent of the principal, with interest at 6 per cent, and payable in bonds of the same class from the dates of default until March, 1877, and thereafter in gold; the second for 40 per cent of the principal, carrying 4 per cent until 1881 and thereafter 5 per cent, payable only out of net earnings. To start the company on its way and to meet present obligations an assessment was proposed of three dollars on the preferred and six dollars on the common stock, in return for which 5 per cent income bonds were to be given; while finally the dividends on the preferred stock were to be reduced from 7 to 6 per cent, and foreclosure was contemplated, so that the opposition of an irreconcilable minority might be more easily overcome.105 According to the figures in the Watkin plan, the old and new capitalization and interest compared as follows:

The amount of capital stock was unchanged.

Total bonded indebtedness

Principal

Interest

Before reorganization,

$54,394,100

$4,073,106

After reorganization,

61,330,241

4,139,240

Increase

$6,936,141  $66,134

Indebtedness on which interest was obligatory:

 

Principal

Interest

Before reorganization,

$54,394,100

$4,073,106

After reorganization,

46,634,134

3,316,238

Decrease

$7,759,966  $756,868

The net earnings for 1874–5 had been $3,715,609, and those from 1871–3 inclusive, with the deductions declared proper in the report of the London accountants, had averaged $4,175,699 each year, so that a safe margin seemed to intervene. The extent of the margin depended, however, on the fixed charges, such as rentals, over and above interest on the funded debt; and although it was proposed to cancel burdensome leases and contracts the actual leeway after 1880 was to be very small indeed. To speak briefly, the plan was definite but not sufficiently radical to meet conditions which were likely to arise. In counting upon the ability of the company to spare considerable sums from revenue for improvements during the next few years, it was leaning on a broken reed; in increasing the nominal amount of bonded indebtedness, it was making a step in the wrong direction; and by interposing additional claims on earnings while leaving the volume of stock the same, it took from the stockholders any very lively interest in the road’s future welfare. The plan was nevertheless accepted by the English securityholders, subject to such modifications as might afterwards be found desirable.106

The next step was to obtain the unanimous acceptance of this Watkin scheme. Messrs. Robert Fleming and O. G. Miller were accordingly sent to New York in February, 1876, to consult with the officers of the company and the securityholders in America. No very vigorous interest was taken on this side, but the Erie directors appointed a committee to confer with the English representatives, and discussions took place for something over a month. The committee criticised the plan proposed from the point of view of the stockholders; they maintained that it would destroy all their interest in the property unless they made further sacrifices, which they were unable to do, and suggested that the funding of from four to eight coupons by the first consolidated, gold convertible, and second consolidated bonds was all that would be needed to put the road in a prosperous condition, provide for steel rails, and for the narrowing of the gauge.107 This was so plainly inadequate that it is a matter of surprise that it was entertained by the English committee; and even they insisted that the stockholders agree to put a majority of the $86,000,000 of stock in the hands of the bondholders as a preliminary, and would do no more than lay the proposal before their constituents.

On their return home in April Messrs. Miller and Fleming stated that the essential conditions to a successful reorganization were:

(1) An effective control of the management by the real owners,—the bondholders;

(2) The restoration of the equilibrium between the compulsory interest charge on the mortgage debt and the minimum net earnings;

(3) A change of gauge from 6 ft. to 4 ft. 8½ in.108

“The foreclosure scheme of the committee” (Watkin plan), said they, “is certainly the soundest plan and would doubtless be preferred by those shareholders who really care for the welfare of their property.” Then referring to the directors’ plan, “If it were possible to present to the bondholders the scheme of proceeding by amicable arrangement as practicable, and therefore as presenting a real alternative for their acceptance, we should suggest to you at the same time to lay the option before them. We feel, however, that that scheme can only be regarded as such an alternative when stockholders enough have signified their willingness to vest their shares in trustees on the footing of it, and so secure an effectual control to the bondholders for a certain period. We must, therefore, content ourselves for the present with suggesting that the committee should proceed with vigor in the direction of foreclosure, at the same time inviting the stockholders to signify their willingness to vest their stock in trustees as above mentioned.”109

The suggestion of the directors was the last alternative plan proposed, and from April, 1876, the only question was how to perfect and carry through the Watkin plan. As eventually put forward, this differed in a few points from its form as earlier announced. The fundamental principle was still the funding of coupons of the first and second consolidated and the convertible bonds. Of these the first consolidated mortgage and sterling 6 per cents were now to fund alternate coupons from September 1, 1875, to September 1, 1879, instead of funding all coupons to March 1, 1876, and receiving cash thereafter: and whereas in the earlier plan mortgage bonds of the same class had been given for funded interest, the later plan created special issues of funded coupon bonds, secured by deposit of the funded coupons, and bearing the same interest as the first consolidated bonds themselves. A more serious difference appeared in the treatment of the second mortgage and the gold convertibles. It will be remembered that it had been proposed in December, 1875, to exchange these for two classes of new bonds, of which 60 per cent were to bear interest at the rate of 6 per cent and 40 per cent were to consist of 4 per cent income bonds. The new plan did away with this permanent reduction in fixed charges. Instead, the second consolidated and convertible gold bonds funded alternate coupons from June 1, 1875, to December 1, 1879, and received a new 6 per cent bond for the principal of their holdings, and funded coupon 6 per cent bonds for the interest thus postponed; the new mortgage bonds not having the right of foreclosure until after default for six successive interest periods (3 years). The funded coupon bonds were to be funded at the existing rate of interest on the second consolidated and convertible bonds, i. e. 7 per cent, so that the reduction in interest was compensated for by the greater volume of securities given; and both classes of these coupon bonds were to bear lower interest at first than that to which they would ultimately attain. The assessment proposed in 1875 was retained in 1876, except that stockholders were given the choice of paying $6 on common and $3 on preferred stock and obtaining therefor income bonds, or of paying $4 on common and $2 on preferred and receiving nothing but new stock, dollar for dollar for their old.110 One-half of the shares of the new company (after foreclosure) were to be issued in the name of one or more sets of trustees, who were to hold them to vote on until a dividend had been paid on the preferred stock for three consecutive years. Provision was made for an issue of $2,500,000 in prior lien bonds, to take precedence of the remainder of the second consols, the proceeds to be applied to capital requirements. Voting power was conferred on the first and second consols, funded income bonds, prior lien bonds, and income bonds, in all about $57,000,000; one vote to every $100 of bonds.111 The property of the company was to be foreclosed by or under the direction of certain reconstruction trustees, for the choice of whom careful provisions were inserted.

Divested of all complications, what this reorganization plan proposed for the salvation of the property was the funding of the coupons on four classes of bonds from 1875 to 1879; the reduction of the interest to be paid on $25,000,000 second consolidated and convertible 7s one per cent per share; and the raising of a certain amount of cash by assessment upon the stockholders; while it dropped the one point of the earlier plan which might have given a key to the solution of the whole problem, viz. the exchange of mortgage and income bonds for the old second consolidated in the ratios respectively of 60 per cent and of 40 per cent. When we remember the desperate straits to which the company had been reduced, the permanent relief seems slight enough; and given the fact, which proved but too true, that the net earnings were to fall off until the road was little more than able to meet the alternate coupons which it was obliged to pay in cash, it appears to have been nothing at all. If we suppose no changes to have occurred in capital account between 1878 and 1883 save those provided for in the plan of reorganization itself, a comparison of the two periods would have stood as follows:

Before reorganization

Principal

Interest

Sterling convertible 6s,

$4,457,714

 $267,463

First consolidated 7s,

12,076,000

 845,320

Convertible 7s,

10,000,000

 700,000

Second consolidated 7s,

15,000,000

1,050,000

  $41,533,714 $2,862,783

Old Mortgages,

13,155,500

 921,062

Guaranteed bonds, etc.,

6,003,360

 449,411

  $60,692,574 $4,233,256

Rentals,

 

 742,226

    $4,975,482

After December 1, 1883

Principal

Interest

Consolidated 7s,

$20,005,794

$1,400,405

Consolidated 6s,

33,516,666

2,011,000

  $53,522,460 $3,411,405

Old bonds,

13,155,500

 921,062

Guaranteed bonds, etc.,

6,003,360

 449,411

Rentals,

 

 742,226

  $72,681,320 $5,524,104

Total before reorganization

60,692,574

4,975,482

Increase,

$11,988,746  $548,622

It thus appears that this reorganization plan contemplated an immediate increase in the cumbrous capitalization of the company to the amount of nearly $12,000,000, and an eventual increase in fixed charges of over $500,000. It offered no reasonable assurance that the solvency of the company could be maintained under the average conditions existing in the past, and left no margin for contingencies of any kind. The trouble lay in the unwillingness of bondholders to sacrifice any part of their holdings to meet difficulties caused largely by inflation over which they had had no control. This reluctance was natural,—it should have been met, however, by the realization that the question was now of the future and not of the past, and that the best interests of the bondholders themselves demanded a reconstruction sufficiently radical to leave no doubt of the ability of the new company to pay its debts.

The plan adopted, foreclosure was in order, and suits which had been begun as early as 1875 were taken up and pushed. In November, 1877, a decree of foreclosure under the second consolidated mortgage was obtained, appointing a referee to conduct the sale, and providing for the sale of the road to representatives of the bondholders in case they made the highest bid. The opposition, which had not been able to prevent the approval of the plan, now appeared with a multiplicity of suits to prevent its consummation. In January, 1878, demands were made to secure a re-accounting from the receiver, and the reopening of an earlier suit of the people against the Erie which had been previously discontinued. On January 18 the postponement of the sale to March 25 was obtained. On January 19 a suit demanded the removal of Receiver Jewett, making sweeping charges of fraud; and on January 30, in still other proceedings, Mr. Jewett was arrested on a charge of perjury for swearing to incorrect statements in the annual report to the state engineer;—a culmination as disgraceful as it was absurd. In February a suit in Orange County, New York, demanded the removal of the receiver, and the appointment of a special receiver during the pendency of the action, with an injunction to prevent the sale of the road. In March a petition of one Isaac Fowler, a stockholder, for permission to examine the company’s books, was granted; argument was heard on the petition of James McHenry to intervene in the foreclosure suits and further to postpone the sale; the application of Albert Betz and others to be made parties was granted; and postponement of sale to April 24 obtained. Last of all, on April 23 and 24, arguments in behalf of John F. Brown and F. W. Isaacson were heard, asking for postponement to a still later date. The litigation availed nothing. Judge Potter in the Brown suit held that the courts could relieve against any injustice occasioned by the sale, and on April 24 the property of the Erie Railway was sold for $6,000,000 under foreclosure of the second consolidated mortgage.112 The new corporation formed to take over the railroad was called the New York, Lake Erie & Western Railroad Company, and had its articles of incorporation regularly filed at the office of the Secretary of State. Mr. Jewett was elected president. In May the receiver was discharged,113 and a new stage in the history of the road began.

For about seven years the Erie was to be free from the necessity for further reorganization. This result, unexpected from the nature of the adjustment of 1878, was due to the vigorous policy of Mr. Jewett, first, in developing the coal traffic for which the Erie was well located; second, in improving the condition of the road; and third, in securing connections with Chicago.

For some time the Erie had been a considerable carrier of coal and a large owner of coal lands as well. In 1877, the first year in which the figures were separated in the annual report, roughly 273,000,000 out of 1,113,000,000 ton miles reported, or something over one-quarter, were due to the carriage of coal; and $2,697,776 out of a total of $10,647,807 of the freight earnings came from that business. The lands owned by the company consisted of 8000 acres in fee, and large tracts in leasehold and mining rights in the anthracite territory in the northeast corner of Pennsylvania; together with 14,000 acres in fee and 13,000 acres of mining rights in the bituminous territory in the northwest portion of the state.114 Mr. Jewett felt that this property could be made of great value to the road, and it was under his administration as receiver that steps were taken to extend the holdings of bituminous land, and to control branch roads leading into the district. The result appeared in a remarkable extension of the company’s business. While the total freight ton mileage from 1878 to 1884 increased 103 per cent, the ton mileage of coal increased 190 per cent, or nearly tripled; and while the gross earnings on ordinary freight grew from $7,950,031 to $11,687,520, those on coal increased from $2,697,776 to $5,437,000. At the same time McKean County, directly north of the coal lands, and containing large tracts purchased by the Erie in the course of its other negotiations, turned out to be an abundant oil-producing district, and made the Bradford branch, which tapped it, Erie’s most valuable collateral property.115

It was partly because of the success of the policy in respect to coal lands that the Erie was enabled to spend large sums in the improvement of its road. In the six years from 1878 to 1883 the company put nearly $14,000,000 into improvements of the road, property and equipment, and of this about one-half was paid out of surplus earnings. In December, 1883, alone, $304,565 were spent, and in the three succeeding months nearly double that amount; making a total of nearly $1,000,000 in the four months previous to April, 1884. The money went toward reducing grades, straightening curves, increasing weight of rails, etc., including the completion of a third rail to Buffalo by which the serious disadvantage of an exceptional gauge was removed. Its result was seen in the decrease in the ratio of operating expenses from 75.13 in 1875 and 77.16 in 1876 to 64.78 in 1883; and in the rise of net earnings per ton mile from .251 cents to .261 cents, while the gross earnings per ton mile decreased from 1.209 cents to .780 cents. No policy which the Erie managers pursued met a more crying need, and none did so much toward maintaining the solvency of the company.

The project of controlling a line of their own to Chicago was brought actively to the attention of the Erie managers by the danger of being cut off from a connection with that city. The original line of the Erie had run to Dunkirk on Lake Erie, from which a branch to Buffalo had soon been built. For western traffic the Erie had had to rely largely on the Atlantic & Great Western (later the New York, Pennsylvania & Ohio), which connected with the main line at Salamanca, New York, and extended by 1884 west to Dayton, Ohio. In 1857 the Erie first leased this property. Placed in receivers’ hands in 1869, the Atlantic & Great Western was re-leased to the Erie on January 1, 1870; sold July 1, 1871, it was again leased to the Erie in May, 1874, only to enter upon a new receivership on December 9 of that year. The persistent attempt to control the road showed the value which the Erie placed upon it, and in fact it was invaluable as a link in a prospective line to the West. Even while the leases were in force, however, the Erie lacked that connection of its own with Chicago which seemed necessary to make it a successful competitor for trunk-line business. In 1882 it was forwarding passengers over not less than five different routes, over no one of which could it feel assured of the continuance of contracts of a favorable nature. In 1881 Mr. Jewett relieved the situation by acquiring control of the franchise of the Chicago & Atlantic Railway, extending from Marion, Ohio, on the line of the New York, Pennsylvania & Ohio towards Chicago, and soon after he entered into a contract with certain private parties for construction of the road. In 1883 he executed a new lease of the New York, Pennsylvania & Ohio, which he hoped would secure for the Erie permanent control of the property, and about the same time (1882) he purchased a controlling interest in the stock of the Cincinnati, Hamilton & Dayton, which extended the Erie system to the important city of Cincinnati. These operations put the Erie upon a footing which was secure so long as the obligations which they entailed could be met, and showed a broad-minded appreciation of strategic necessities. The terms of the arrangement with the Chicago & Atlantic were as follows: For the construction of the road the Erie agreed to give to the directors the entire proceeds of the mortgage bonds of that branch ($6,500,000), and its entire capital stock ($10,000,000); making an aggregate of $61,710 per mile of line. The proceeds were, however, to be deposited with the president of the New York, Lake Erie & Western in trust, together with certain subsidies which had been voted by the counties and townships along the line, and upon him was to devolve the duty of seeing to the proper application thereof; and besides this, 90 per cent of the stock was to be deposited and an irrevocable proxy given thereon for the thirty years’ life of the bonds.116 The obligation which the Erie assumed amounted in practice to guaranteeing that the road should be constructed for the sum provided, and that interest on the bonds should be paid. In leasing the New York, Pennsylvania & Ohio the Erie involved itself more heavily. As lessee it agreed to pay the minimum sum of $1,757,055 yearly (the net earnings of 1882); the actual rental to be 32 per cent of all gross earnings up to $6,000,000 and 50 per cent of all gross earnings above $6,000,000, until the average of the whole rental should be raised to 35 per cent, or until the gross earnings should be $7,200,000. If 32 per cent of the gross earnings should ever be less than the $1,757,055 to be paid yearly, then the deficiency was to be made up, without interest, out of the excess in any subsequent year. Out of the rental the New York, Pennsylvania & Ohio was to pay the interest on its prior lien bonds, the rentals of its leased lines, the expenses of maintaining its organization in Europe and America, and for five years a sum of $260,000 each year to the car trust.117 Finally, in purchasing the Cincinnati, Hamilton & Dayton, the Erie gave to the holders of the $2,000,000 of stock which it bought beneficial certificates to the amount of $1,500,000, on which it agreed to make good any failure of the Cincinnati company to pay 6 per cent per annum.

But though the Erie managers did their best with the conditions which they were called upon to face, they were unable to hold the company up under the enormous capitalization and heavy charges left by the reorganization of 1874–8, at a time when rate wars were sapping its resources, and when contracts which it was being forced to make were entailing an annual loss.118 In spite of the declaration of sufficient dividends on the comparatively small amount of preferred stock to terminate the voting trust, it is certain that for most of the years from 1874 to 1884 the solvency of the road was a precarious matter, and that there never was a time when any considerable falling off in earnings or any severe shock to its credit would not have driven it to the wall.

Such a shock was preparing in the early months of 1884. For some weeks before the last of April there had been a tendency for the quotations of Erie securities to fall; no reason was assigned, but it was hinted that default might be made in the payment of the June interest on the second consols, and that a receivership was not unlikely. This weakness was accompanied, and perhaps accentuated, by a strike of the brakemen on the New York, Pennsylvania & Ohio in consequence of an order reducing the number of brakemen on each train from three to two. The truth of the matter came out in May, when the failure of the Wall Street firm of Grant & Ward both precipitated a stock exchange panic and laid bare the straits to which the company had been reduced. Investigation showed that a large floating debt had been piling up for four principal purposes: First, advances to the Chicago & Atlantic Railroad; second, advances for coal mines; third, advances for improvements on the Hudson River at Weehawken; fourth, equipment instalments.119 Attempts to raise funds to cover the debt had resulted in the negotiation of promissory short time notes with the firm of Grant & Ward, for which $2,500,000 of Chicago & Atlantic second mortgage bonds had been deposited as security. The company had been attracted to Grant & Ward by their offer to purchase and dispose of Chicago & Atlantic bonds at a price 15 per cent above that offered by any other parties;120 and had trusted so implicitly in their integrity as to deposit notes and collateral for its short time loans detached and independent, one from the other, so that Grant & Ward were able to, and did, fraudulently raise money upon them to an amount much larger than the advances they had made. The losses entailed by the transaction were serious, and the blow to Erie’s credit was even more severe. The floating debt which had been so hard to carry became doubly menacing now that the possibility of further short time loans was practically cut off; and to cap the climax, the earnings for the first half of the year 1884 showed an unusually large decrease with the cessation of the fall business. Under these circumstances it was the part of wisdom to take advantage of every loophole of escape, and the peculiar provisions of the second consolidated mortgage, denying to these bonds the right of immediate foreclosure in case of default, were turned to for relief. It will be remembered that by the terms of the reorganization of 1878 no right of action was to accrue to the second mortgage bondholders until on each of six successive due dates of coupons (three years) some interest secured by the second indenture should be in default. This being the case the Erie directors decided to pass the June interest on these bonds. “As a general rule,” said they in a circular, “the business and earnings of the company are much less for the first half than for the last half of the year. The falling off in earnings for the first six months of the previous year has been unusually large. The coupons of the second consolidated mortgage bonds are due and payable on the first of June prox.... Under ordinary circumstances the board might at the present as on the former occasions provide to some extent for the deficit of the first six months, relying on the usual increase in earnings of the last half of the year, but in the present depressed condition of the business of the country and of the earnings of this company, as well as of others, the board does not feel at liberty to deal with anything but the business and earnings as now ascertained, and therefore deems it wise to accept the provisions of the mortgage as the lawful rule for their government in the existing emergency....”121

However necessary the action, the bondholders of the company could not have been expected to receive it quietly; and naturally again, the indignation was intense among the English securityholders, to whom, more than to any one else, the existing situation was due. In June, 1884, a meeting of stockholders of the company was held in London, at which much complaint was made of the fall in value of the securities of the company, and an inquiry into the management was demanded. A committee was appointed, and two of its members, Messrs. Powell and Westlake, landed in New York July 15, with protestations of a friendly spirit toward all concerned. The situation was not encouraging. The day before their arrival President Jewett had offered his resignation, and the directors were busy selecting his successor; a large floating debt was demanding most vigorous attention, and confidence in the company was at a low ebb. Beyond a doubt the raising of a large amount of cash, $4,000,000 to $5,000,000, was a pressing necessity, and the English representatives were anxious to make it plain that at least a fair share of this should come from American as well as from English bondholders. Force of circumstances compelled them to give assurance that the money would be raised, and this done, Mr. John King accepted the position which Mr. Jewett professed himself ready to resign. Pending the annual election Mr. King took the position of Assistant to the President.

On their return to London Messrs. Powell and Westlake reported the floating debt to be as follows:

Unpaid coupons, June 1, 1884,

$1,007,922

Balance of actual and early maturing liabilities other than the June 1 coupons over and above cash in hand and money assets considered good and available,

$4,447,316

“All the purposes, the expenditures on which have caused the floating debt,” said they, “seem to us to have been in themselves wise and politic, but the piling up of a large floating debt for even the best of purposes is always more or less imprudent and dangerous. The company’s credit might have borne the strain of the panic, but it was broken down by the Grant & Ward disaster, and the funding of its floating debt is now indispensable.... We have suggested to the president and directors, and now recommend to the committee that an effort should be made without delay to raise a permanent loan on the securities available for a total of $5,000,000.”122 This, it will be observed, was the old remedy. Inability to meet current expenses was to be removed by capitalizing the debts which this inability had caused.

The year 1885 was taken up with suits brought against the Erie by certain of its branch lines. In February the directors of the Buffalo & Southwestern Company brought suit to recover $345,000 interest defaulted during the previous January. The complaint alleged that the Erie was insolvent, and asked that it be restrained from using the gross receipts of the road until the default should have been made good. The Erie paid the back interest, but in July, after another default, an injunction was obtained forbidding it to divert any part of the earnings received or to be received from this property. It was recited that on May 24, 1881, the Buffalo & Southwestern had been leased to the Erie for 35 per cent of the gross earnings, subject to certain deductions; that the Erie had delayed payment of the rental due in January, 1885, and had refused to pay that due in July, 1885, but that it was still receiving the gross earnings of the plaintiffs’ road, and had applied these to the payment of its debts other than the rentals of this road.123 In November, after the Erie’s other troubles were settled, the litigation was terminated by an agreement to reduce the Buffalo & Southwestern rental from 35 per cent to 27½ per cent. Other suits arose, directly or indirectly, because of the control which Mr. Jewett maintained as trustee of the stock of the Chicago & Atlantic and the Cincinnati, Hamilton & Dayton railways even after his resignation from the Erie Company. On the one hand President King was anxious to repossess himself of these important branches for the Erie, and on the other Mr. Jewett was not disinclined to do what damage he could to the managers who had succeeded in supplanting him. In the matter of the Chicago & Atlantic Mr. Jewett gained the first victory in a temporary injunction forbidding the Erie to divert traffic from this line contrary to contract. This injunction was soon, however, substantially vacated, and President King in his turn obtained a decision that Jewett had been made trustee of the Chicago & Atlantic simply because he had been at the time vice-president of the New York, Lake Erie & Western Railroad Company and could be relied upon to control the road as the western outlet of the Erie. A receiver was subsequently appointed and the road reorganized as the Chicago & Erie Railroad Company, the Erie agreeing to guarantee payment of its first mortgage bonds, and receiving in return the $100,000 of capital stock and $5,000,000 in income bonds, besides $2,000,000 first mortgage bonds which were in part payment of old advances.124 In his action concerning the Cincinnati, Hamilton & Dayton President King was less successful; and Mr. Jewett was sustained in his refusal to deliver proxies for the stock held to the larger company. The result was to turn the Erie to the Big Four, upon which, instead of upon the Dayton road, the management was for some time to rely for an entrance into Cincinnati.

During these various contests the suggestions of the English committee were not lost to view, and in the latter part of 1885 they crystallized into definite propositions. The floating debt then consisted of two parts: first, the defaulted coupons on the second consolidated bonds; and second, the current liabilities accumulated for the purposes before described. The relief proposed was likewise in two parts, and involved the issue of a 5 per cent mortgage, secured by deposit of the second consolidated coupons maturing and to mature in June and December, 1884, June, 1885, and June, 1886, and a 6 per cent mortgage upon the property of the Long Dock Company, comprising the valuable terminals of the Erie at Jersey City.125 The funding of the coupon issue proved simplicity itself; the funded coupons were exchanged for bonds of the new gold mortgage, which were to be redeemable at 105 at the pleasure of the company.126 By the end of 1886 these bonds had been accepted by the holders of $32,982,500 of the outstanding $33,597,400 of the second consols, and $3,957,900 of them had been issued. Dealing with the Long Dock Company was slightly complicated by the fact that 8000 shares of that company were pledged as part security for the issue of Erie collateral bonds. To free them $800,000 in cash were deposited with the trustee of the mortgage, which were in turn employed by him to pay off $727,000 of the 6 per cent collateral bonds, thus reducing the interest charge on that issue $43,620 per annum. This done, the Long Dock Company extended the lease of its property and franchises to the Erie to 1935 at a rental of $480,000 per annum, and contemporaneously therewith placed a consolidated mortgage upon its property to secure $7,500,000 of 50-year 6 per cent gold bonds; of which $3,000,000 were reserved to retire existing indebtedness, and the proceeds of $4,500,000 were paid to the Erie for the cancellation of its floating debt. The total result was to increase fixed charges by $270,000 of interest at 6 per cent on the Long Dock bonds, and by $197,895 on $3,957,900 of the new funded 5s, less the reduction of $43,620 on cancelled collateral bonds; leaving a net increase of $424,275.127 For its ingenuity the scheme was to be admired; from any other point of view it was to be condemned as another example of that borrowing to pay interest which had brought the Erie to its existing straits. The incapacity of the creditors of the company to realize that continued borrowing of money to pay current obligations was only to ensure repeated bankruptcy seemed complete.

After this new “salvation,” the Erie started once more on its laborious attempt to pay interest on its outstanding bonds. From 1887 to 1892 the business increased somewhat, and despite a decrease in the average receipts per ton mile128 a gain of about $4,700,000 in gross earnings was secured; from which is to be deducted an increase of $310,996 in fixed charges, and of $4,076,111 in operating expenses.

The prohibition of pooling in 1887 affected the company unfavorably. Previous to the passage of the Interstate Commerce Act the other lines had been paying it an annual average of $42,500 on west-bound business from New York for shortages under the operation of the trunk-line pool, besides about $88,000 annually on east-bound dead freight and $19,770 on live stock. These payments ceased when the Act was passed, although a differential on west-bound traffic was subsequently allowed.129 But the leakage which was most apparent lay in the large rental and heavy operating cost of the New York, Pennsylvania & Ohio. It will be remembered that the Erie had leased that road for 32 per cent of the gross earnings when earnings were $6,000,000 or under, and 50 per cent when they should be above that figure. In 1887 this was amended so as to provide that for every increase of $100,000 over $6,000,000 in the gross earnings the Erie should pay to the lessor an additional one-tenth of one per cent of such gross earnings until the gross earnings should be $7,250,000, and the rental 33½ per cent, after which the percentage was not to increase.130 Under the old lease the Erie had guaranteed to carry over the line 50 per cent of all its east-bound and 65 per cent of all its west-bound through traffic—under the new lease, these maxima were increased to 55 per cent and 70 per cent; but even this failed to make the branch road pay. Its grades were high, its equipment and sidings were limited, its cost of operation was well above 68 per cent; and the increase in tonnage provided for emphasized each and every disadvantage. Up to 1893 the results of operations were as follows:

   

Loss

Profit

First 5 months to Sept. 30,

1883

 

$199,540

Twelve months ending Sept. 30,

1884

 $270,281

 

1885

 239,820

 

1886

 

51,322

 

1887

 

91,965

 

1888

343,911

 

1889

331,134

 

1890

 

77,376

 

1891

19,586

 

1892

425,888

 

1893

197,106

    $1,827,726 $420,203

Net loss,

 

1,407,523

It thus appears that the terms of the amended lease were in reality more onerous than the contract which they succeeded, and that whatever the value of the branch as a feeder, its operation involved large and fairly regular deductions from the net income of the parent line. Emphasis on these facts was laid in the annual reports, and frequent demands were made that the New York, Pennsylvania & Ohio bring its road up to the standard of like connections of through trunk lines. Meanwhile improvements were imperative on the Erie’s own lines: new equipment was needed, new rails and new motive power, and at the same time surplus earnings were somewhat less. The directors adopted the expedient of allowing current liabilities to accumulate, and put $8,496,572 into the road from October 1, 1884, to September 30, 1892, of which $3,351,977 represented surplus earnings, $2,375,400 increase in bonded indebtedness, and the balance floating debt. In the matter of traffic policy they paid particular attention to the coal business, which, however, lost ground as compared with other freight, and to the local business, which it was the policy of the management to encourage. In 1890 the board declared that “the time had arrived when extraordinary expenditure for improvements and the necessities of the property were no longer necessary.”131 In 1891 3 per cent on the preferred stock was paid, the first dividend since 1884.132

From 1887 to 1893, with all its struggles, the Erie was continually on the verge of failure. The capitalization in 1892 was at the enormous total of $163,607,485 on an operated mileage of 1698 miles, while fixed charges were $4993 per mile, and the available net revenue but $4830.133 Given, with this condition, a gross floating debt which amounted in 1892 to $9,163,166, and represented in a large measure the inability of the company to make necessary repairs, no further explanation is needed for the bankruptcy which soon took place.

Early in 1893 rumors were current that the Erie might be thrown into the hands of a receiver. The reports were vigorously denied, but on July 25, nevertheless, on application of the company itself, Judge Lacombe appointed President John King and Mr. J. G. McCullough as receivers of the property. The measure was taken to avoid the sacrifice of collaterals deposited. “Within the last few weeks,” said President King, “during the severe money stringency the floating debt of the Erie ... became impossible of renewal, and in order not to sacrifice the best interests of the company it was decided to place the road in receivers’ hands, and preserve the system intact, and preserve and develop the transportation business for the company.”134 The action occasioned no surprise, and there was even a disposition to praise the management for having preserved the solvency of the company. “The company was bankrupt de facto when it passed to its new control,” says Mott, and “that the time when it must become bankrupt de jure was held off so long was a striking demonstration of the tact and resourcefulness which the new régime had been able to bring to bear in the management of the company’s unpromising affairs, and in judicious shifting and manipulating of the heavy burdens Erie bore upon its chafed and weary shoulders.”135 What a receivership meant was a new opportunity to put the company upon a genuinely sound foundation, by providing new capital to pay off the floating debt and to allow for future additions and improvements, and by getting fixed charges to a point well within the road’s capacity to earn. We shall see what use was made of the chance.

The matter of reorganization was set about at once. On January 1 a plan appeared, prepared, at least nominally, by a special committee chosen by the directors,136 and backed by the well-known firms of Drexel, Morgan & Co. of New York and J. S. Morgan & Co. of London.137 By its terms no mortgage senior to the second consolidated mortgage was to be disturbed save the first mortgage, which matured in 1897. The bonds to be dealt with were thus reduced to $41,481,048, besides which provision had to be made for the floating debt and for future capital requirements. The plan proposed to authorize a blanket mortgage of $70,000,000 at 5 per cent, of which $33,597,000 were to exchange at par for the 6 per cent second consolidated bonds and funded coupons thereof, $4,031,400 to exchange for the funded coupon bonds of 1885, and $508,008 for the income bonds. Of the balance, $6,512,800 were to be reserved to settle with the old first lien and collateral trust bonds, $15,915,208 to supply capital requirements in the future, and $9,915,208 to be offered for subscription in order to pay the floating debt. The new management did not conceive that these last bonds could be sold to advantage in the general market, but imposed as a condition of the exchanges as above that second consols, funded coupon, and income bonds should subscribe at 90 to the extent of 25 per cent of their holdings; hoping that the grant of the right of immediate foreclosure upon default would induce the second consols to come in. Both these consols and the funded coupon bonds of 1885, it may be remarked, were to be kept alive and deposited with the trustee for the protection of the new bonds. Stated in tabular form the distribution of securities was to be as follows:

To acquire the existing second consols,

$33,597,400

To acquire the funded coupons of 1885,

4,031,400

To acquire the income bonds,

508,008

For subscription as above,

9,915,208

To acquire the old reorganization first lien and collateral trust bonds,

6,512,800

To be expended for construction, equipment, etc., not to exceed $100,000 in any year, except that $500,000 might be used to acquire existing car trusts,

15,435,184

Total,

$70,000,000

The new mortgage was to cover the property of the New York, Lake Erie & Western, including its leasehold of the New York, Pennsylvania & Ohio, and the capital stock of the Chicago & Erie Railroad.138 There was to be no assessment, no syndicate to raise money, and no voting trust.

This plan was advanced as adequate to restore the prosperity of the company. Examination will show its weakness. It comprised two measures of relief: first, reduction of interest by one per cent on the second consolidated bonds; second, the settlement of the floating debt. The first might be thought to have been the kernel of the plan, and the reduction in fixed charges the principal thing aimed at. That it was not is shown by the fact that so liberal were the new bond issues that the total fixed charges after reorganization were to be greater than those before. The floating debt which remained had arisen from lack of funds with which to make current and necessary improvements and repairs. This debt was the immediate cause of the failure of the company, and its cancellation was the real purpose of the plan. The method proposed was a forced levy upon bondholders, but the levy took, not the form of an assessment, but that of a subscription to new bonds on which payment of interest was to be as obligatory as any other charge. The operation differed, therefore, from an ordinary sale of securities in the more favorable selling price which it assured. It did little, however, to lighten the burden which had crushed the company. The only bright spot in the plan was the provision for future construction and improvement, which, though involving a still further increase in indebtedness, was justified because these improvements would serve not only to maintain but to make greater the earning powers of the company. Finally, it was the peculiar effect of this plan that it put the pressure imposed upon the wrong parties: the second consolidated and other junior bondholders were to be forced to subscribe to the new issue, when in fact it was the stockholders who should have been turned to, and whom it was consonant with no sound principle of finance to spare. Other matters come out in the objections raised by bondholders.

Opposition to the plan was vigorously headed by men like Kuhn, Loeb & Co., E. H. Harriman, August Belmont, Hallgarten, Peabody, Vermilye, and others.139 In England a meeting of dissentients was held and a committee was elected;140 in America the first formal action was the dispatch of a letter to the Erie managers by opposing bankers which is important enough to be quoted in full.

“Consultations and comparisons of views have recently taken place,” said these gentlemen, “between the owners and representatives of the second consolidated mortgage bonds and other bonds of your company, to whom the proposition as detailed in your circular of January 2 is not satisfactory.... Your plan seems unjust, inasmuch as it demands a permanent reduction of interest on the bonded indebtedness for which no adequate equivalent is offered, and it levies a forced contribution upon the bondholders through the demand for a subscription to new bonds at a price considerably over and above the market value these new bonds are likely to command, while the fixed charges proposed to be created appear to be considerably larger than, in the light of past earnings and experience, the property of the company can carry with safety.

“Instead of 5 per cent bonds, as provided in the published plan, 4 per cent bonds, in our opinion, should be issued, while for the interest to be surrendered the bondholders should receive an equivalent in interminable non-cumulative 4 per cent debentures, interest payable if earned; the holders of the debentures to have sufficient representation in the management to protect them.

“The floating debt should be liquidated from the proceeds of an adequate amount of new 4 per cent bonds (and debentures if desirable), which shall be offered to the shareholders and bondholders at a price rather below than above the probable market value of the new securities, and under the guarantee of an underwriting syndicate.

“Provision should also be made to obtain the conversion on fair terms of the reorganization prior lien bonds into the new bonds, so that it shall become practicable to secure the new 4 per cent bonds at once by a lien second only to the ‘Erie first consolidated 7 per cent bonds’; the new 4 per cent bonds to be issued under a general mortgage to an amount sufficient to provide for future additions and improvements, and with adequate provision for the taking up of the underlying bonds, and the issue of 4 per cent bonds in their stead.... Any plan now adopted for the readjustment of the finances of your company should seek, as its first object, to reduce the permanent charges so well within the earning capacity of the property as to make another default in the future an improbability.... We trust this communication will be received in the spirit in which it is submitted.”141

The directors refused to modify their plan, and the bankers, therefore, notified them of the election of a protective committee.142 On March 6 a meeting of stockholders approved the plan, and the same week Messrs. Drexel, Morgan & Co. gave notice that, having received deposits of a majority of each class of bonds, they had declared the plan operative as announced.143

Defeated in their appeal to the securityholders, the opposition turned to the courts. As a preliminary, they obtained an opinion from the well-known firm of Messrs. Evarts, Choate & Beaman, which held, first, that the Erie could not legally pay interest on the new bonds proposed until it had paid the interest on every one of the old second mortgage bonds, regardless of whether the latter was deposited with the reorganization committee; second, that if the old second mortgage bonds which were deposited as security for the new issue should be kept alive as proposed, the company would be increasing its obligations beyond the legal limit;144 and third, that much of the stock voted at the special meeting at which the new mortgage had been authorized was not really owned by the persons who had issued the proxies thereon as the law provided.145 Following the opinion, suit was commenced by Mr. Harriman in April for an injunction against the recording of the new mortgage, on the ground that the Drexel & Morgan proxies did not represent the actual stockholders, and in June by one John J. Emery to prevent the execution of the mortgage. Judge Ingraham in the Supreme Court Chambers denied an injunction, using in his opinion the following language: “While it is clear,” said he, “that there are certain obligations resting upon the majority to refrain from infringing the legal right of the minority, and that a court of equity will enforce and protect the rights of the minority, still, when the holder of a very small number of bonds or shares of stock seeks to enjoin a very large majority from carrying out a plan such majority deem to be for their benefit, I think the court should not interfere unless it plainly appears that some legal right of the minority is endangered.”146

What could not be accomplished by the hostile bankers was nevertheless to happen from the inherent weakness of the plan itself. It has been said that the new scheme involved an increase instead of a decrease in fixed charges. How this was to be met was not demonstrated; and already in June, 1894, it was necessary to announce that the coupons then due would not be paid for the present. In December matters were even worse, and a circular from Drexel, Morgan & Co. confessed the company’s inability to meet the coupons maturing. “Nevertheless,” the firm continued, “it seems to us inexpedient to treat the inability of the company to pay interest as an occasion for present foreclosure without giving a further chance to the company, especially as payment of bondholders’ subscriptions to the new bonds has not yet been called to provide the company with money necessary to pay the floating debt. It is, therefore, now proposed that the new bonds be issued with the coupons of June 1, 1894, and December, 1894, attached, but stamped as subject to a contract with the company which shall provide that they shall be paid as soon as practical out of the first net earnings over and above the railroad company’s requirements to meet interest and rentals accruing after December 1, 1894, except in case a default on later coupons shall give power of foreclosure, in which event the stamped coupons shall retain all their original rights.” The modification was assented to,147 but could not save the plan. Reluctantly the managers were forced to abandon it, and to consent to more radical propositions.

August 26, 1895, the new and final reorganization plan appeared. There were to be issued:

$175,000,000 first consolidated mortgage 100-year gold bonds;

30,000,000 first preferred 4 per cent non-cumulative stock;

16,000,000 second preferred 4 per cent non-cumulative stock;

100,000,000 common stock.

The first consolidated mortgage bonds were to be divided into prior lien bonds to the amount of $35,000,000, and general lien bonds to the amount of $140,000,000; the former to have priority of lien over the latter for both principal and interest. Both classes of bonds were to be secured by mortgage and pledge of all railroads and properties of every kind embraced in the reorganization as carried out and vested in the new company, and also all other properties which should be acquired thereafter by issue of any of the new bonds. Both issues were to bear interest at 4 per cent, except $29,435,000 of the general lien bonds, which were to bear 3 per cent for two years from July 1, 1896, and 4 per cent thereafter. The stock was to rank for dividends in the order given. Provision was made that no additional mortgage could be put upon the property to be acquired, and that no additional issue of first preferred stock could be made except with the consent in each instance of the holders of a majority of the whole amount of each class of preferred stock, given at a meeting of the stockholders called for that purpose; and with the consent of the stockholders of a majority of such part of the common stock as should be represented at such meeting, the holders of each class of stock voting separately; also that the amount of second preferred stock could not be increased except with like consent of the holders of a majority thereof, and a majority of such part of the common stock as should be represented at the meeting. All classes of stock were to be deposited in a voting trust until December 1, 1900, and until the expiration of such further period, if any, as should elapse before the Erie should in one year have paid 4 per cent cash dividends on the first preferred stock; though the voting trustees might terminate the trust earlier at their discretion.

Generally speaking, the prior lien bonds were relied on to pay the floating debt, to buy in the New York, Pennsylvania & Ohio, and to retire certain prior liens of the old company. The general lien bonds were reserved for undisturbed bonds, and, with the first preferred stock, exchanged for junior New York, Lake Erie & Western securities. The second preferred stock went for old preferred stock and income bonds, and the new common stock exchanged for old common.

The distribution was as follows: The old New York, Lake Erie & Western reorganization first lien and collateral bonds were paid off from the proceeds of the new prior lien bonds; the second consols received 75 per cent in new general lien bonds and 55 per cent in preferred stock; the funded coupon bonds of 1885 received 100 per cent in general lien bonds, 10 per cent in first preferred, and 10 per cent in second preferred stock; the income bonds 40 per cent in general liens and 60 per cent in first preferred stock; the New York, Lake Erie & Western preferred stock, on payment of assessment, 100 per cent in new common. For all other bonds included in the plan there were reserved general lien bonds in amounts usually equal to the par of the securities to be retired.

The cash requirements and the floating debt were as follows:

Floating debt, receivers’ certificates, etc.,

$11,500,000

Collateral trust bonds (Erie), at 110,

3,678,400

Reorganization first lien bonds (Erie),

2,500,000

Early construction and expenditures,

5,337,288

Car trusts for three years,

2,000,000

  $25,015,688

The necessity for retirement of the first lien and collateral bonds arose from the early maturity of the former, and from the fact that stocks and bonds of various Erie properties which it was desirous to consolidate with the new company were pledged for the latter. The wisdom of allowing for early construction and expenditure could not be denied; car trust payments were required to preserve the rolling stock, and the floating debt and receivers’ certificates called obviously for cash. Provision was made, first, by an assessment on the stock of $8 on preferred and $12 on common, with higher payments in case of delay, and estimated to yield $10,023,368; second, by a contribution from the New York, Pennsylvania & Ohio of $742,320; and third, by the sale of $15,000,000 prior lien bonds as indicated above. A syndicate of $25,000,000 was formed to subscribe to the prior liens, and to take the place of and succeed to all the rights of stockholders who should not deposit their stock and pay the assessment thereon.

With the settlement of cash requirements, unification of the Erie system was assured; “subject only to the undisturbed bonds and stock until retired by use of the bonds reserved for that purpose or the rentals corresponding thereto.” “The new bonds and stock will,” said the plan, “represent the ownership (either in fee or in possession of securities) approximately of:

N. Y., L. E. & W. proper,

538 miles

N. Y., P. & O.,

600

Chicago & Erie,

250

N. Y., L. E. & W. Auxiliary Companies,

550

Total,

1938

miles

148

—with valuable terminal facilities at Jersey City, Weehawken, Buffalo, etc., and also one-fifth ownership in the stock of the Chicago & Western Indiana Railroad Company. Also all the Erie coal properties, ... representing an aggregate of 10,000 acres of anthracite, of which about 9000 acres are held in fee, and 14,000 acres of bituminous, held under mining rights ... also the Union Steamboat Company, with its terminals and other properties in Buffalo, and its fleet of five lake steamers on which the Erie mainly depends for the lake and railway traffic,” etc.

Fixed charges under the plan were estimated at $7,850,000. Fixed charges in 1894 had been $9,400,000. For the first two years after reorganization, moreover, the charges were to be further reduced by $300,000 per annum, as the new general lien bonds were to bear only 3 per cent interest during that period; and an additional saving of $1,000,000 was looked for when the exchange of old bonds for new on the maturity of its existing prior issues should have been eventually completed. This sum of $7,850,000 the company was expected to have no difficulty in earning in view of the immediate expenditure of $5,337,208 for new construction, additions, and betterments, and the gradual distribution of the proceeds of $17,000,000 of general lien bonds to the same end. The compensation to Messrs. J. P. Morgan & Co. and Messrs. J. S. Morgan & Co. for their services as depositaries, and in carrying out the plan was put at $500,000 and expenses. Foreclosure was finally to take place and a new company was to be organized.

This plan differed from its abandoned predecessors in four important particulars, each of which was in its favor:

(1) It employed bonds and stock instead of bonds alone;

(2) It lowered instead of increased fixed charges;

(3) It procured cash from stockholders instead of from second consolidated mortgage bondholders; and

(4) It absorbed the New York, Pennsylvania & Ohio into the Erie system instead of continuing the lease thereof.

In the employment of bonds and stock instead of a simple issue of bonds, the Erie managers adopted what experience has shown to be the best method of dealing with the complicated situation arising from a great railroad default. The use of securities on which return was optional side by side with those on which return was obligatory tended both to protect the railroad company when earnings were low, and to benefit the recipients of the new securities when earnings were high. As worked out, it gave to the second consols and funded coupons a less return in the one case, and an equal or greater return in the other, than did the plan of 1894, and to the income bonds, though it offered no chance of equal gain, it at least promised a minimum below which payments should not fall. It further made a far nicer recognition of the relative priorities of different classes of old bonds possible, and whereas the previous plan had made the same demands on, and had given the same return to the second consols, the funded coupon bonds of 1885, and the income bonds, the new plan gave, as has been pointed out, to the first 75 percent in general lien bonds and 55 per cent in first preferred stock; to the second, 100 per cent in general lien bonds, 10 per cent in first preferred, and 10 per cent in second preferred; and to the third, 40 per cent in general liens and 60 per cent in first preferred stock. Income, coupon, and consolidated bonds benefited alike from the assessment upon the stock, which laid the burden of raising cash upon the owners of the road, where it most properly fell. No species of security was given for the assessment, not even common stock, with which the managers might well have been generous; although it must be remembered that the sale of $15,000,000 prior lien bonds for cash was part of the reorganization plan. It may be remarked that since, on July 2, 1895, the common stock was being offered at 10⅝, with no sales, and the preferred at 22½, and since the chance for dividends which the new stock was to enjoy was most remote, it was perhaps well that the syndicate guarantee of the payment of assessments had been obtained. Fixed charges by the new plan were lower, as a result of the liberal use of stock in the exchanges and the cancellation of floating debt as above; while the terms under which the outstanding New York, Pennsylvania & Ohio bonds were retired were the most drastic part of the scheme. In all, the total mortgage indebtedness of the Erie Company and its leased or controlled lines of $234,680,180 for January, 1896, was reduced to $137,704,100 by June 30 of that year.149

A weak point in the plan was, nevertheless, the small reduction in bonded indebtedness which it occasioned. Although, to repeat, the bonded indebtedness of the system was reduced from $234,680,180 to $137,704,100, the shrinkage was more apparent than real, since it consisted chiefly in the exchange of stock for New York, Pennsylvania & Ohio mortgage bonds, on which interest had not been paid by the Erie, and but seldom by the New York, Pennsylvania, & Ohio itself. These securities were slashed in most drastic fashion, particularly such of them as were inferior to the first mortgage. The amount of the reduction in the volume outstanding is indicated by the fact that for $5000 first mortgage New York, Pennsylvania & Ohio bonds were given $1000 Erie prior lien bonds, $500 Erie first preferred, $100 Erie second preferred, and $750 Erie common stock; and for $500 second mortgage, or for $1000 third mortgage, were given $100 Erie common stock. If, now, we exclude the New York, Pennsylvania & Ohio bonds from our consideration of the funded debt, we find the indebtedness of the Erie system on January 1, 1896, excluding the non-assumed New York, Pennsylvania & Ohio bonds to have been $121,399,431; and on June 30, excluding the new prior lien bonds used to exchange for these securities, to have been $123,304,100; or an increase through the reorganization of $1,904,669.150 Further, there was an accompanying increase in the capital stock of the combined companies, which did not, of course, involve an increase in fixed charges, but which increased the volume of securities outstanding.151 What the reduction in the capital of the New York, Pennsylvania & Ohio, joined with its amalgamation with the Erie system, did do was to lessen the burdens of that line to the parent company. For many years the Erie had engaged to operate the branch for 68 per cent and had paid 32 per cent of its gross earnings to the New York, Pennsylvania & Ohio, to be applied to payment or partial payment of interest on the excessive issues which were now retired. It was probably to be long before an operating ratio of 68 per cent could be successfully maintained; but the Erie after reorganization was obliged to turn over, not 32 per cent of gross earnings, but 4 per cent on the $14,400,000 prior lien bonds which had been given for New York, Pennsylvania & Ohio securities, or an amount of $576,000; which amounted to a reduction of the minimum rental of more than one-half, and of the sums actually paid of almost three-quarters.152

Turning again to fixed charges, we find them estimated, after the first two years, at $7,850,000. The average net earnings for the period 1887–94 had been $9,331,250. These earnings will not serve strictly as a basis for calculation, for from 1887 to 1892 they include an average of perhaps $750,000 derived from Lehigh Valley trackage payments and other sums now discontinued. With the deduction, therefore, of this amount from the net earnings of the period named, the average is reduced to $8,768,750; or $918,750 more than it was thought fixed charges would be. When it is considered that this $918,750 represented the sum available for dividends on $146,000,000 of outstanding Erie stock, it is plain that the over-capitalization of the company in 1895 was still very great.

With these comments it is necessary to leave the plan. It was far the best that had ever been applied to the rehabilitation of Erie’s affairs; it was discriminating in its nature, and, thanks to the increasing prosperity of the last eleven years, it has been fortunate in its results. In August, 1895, a decree of foreclosure was signed in the city of New York, and the following November the property was sold under the second consolidated mortgage, and purchased by the reorganization committee for $20,000,000.153

Since 1895 the Erie has shared in the prosperity of the country. Its ton mileage has increased from 3,939,679,175 in 1897 to 6,275,629,877 in 1907; its gross earnings have grown from $31,497,031 to $53,914,827; and its net earnings, which had hovered for so many years near or below the level of fixed charges, have now soared away above. Under these circumstances it is but natural that large sums should have been applied to improvements. Between December 1, 1895, and June 30, 1907, $12,732,486 were spent in the purchase of land, in yards, stations, and buildings, in reducing grades, relocating tracks, and in other ways, and charged to capital; $36,511,046 were spent for new equipment, and charged to capital; and $8,625,307 were taken from income for equipment and improvements of various sorts. These expenditures have had a most gratifying result. The average train load has grown from 224.74 tons in 1895 to 471.67 in 1907, although coal now constitutes a smaller proportion of the freight; and the average revenue per train mile has more than doubled, in face of a revenue per ton mile which has only slightly increased. In 1907 the Erie’s ton mileage was 59 per cent greater than in 1897, and its passenger mileage was 73 per cent greater, but the expense of conducting transportation had increased but 27 per cent. Instead of freight cars with an average capacity of 22½ tons the company now uses cars which average 34 tons. Instead of locomotives which on the average could exert a tractive force of only 24,500 pounds as late as 1901, it has now engines which average 31,000. Freight train mileage is 2,600,000 less than it was in 1896, and passenger train mileage has only slightly increased.

And yet, with all this prosperity, it cannot be said that the Erie enjoys an assured position. In 1907 it had to pay out 89 per cent of the largest income which it had ever received for operating expenses, fixed charges, and taxes. Of its net income of about $6,000,000 the modest dividends of 4 per cent on its first and second preferred stock absorb some $2,500,000, and the widespread financial difficulties of 1907 have led its management to declare the dividends for that year payable in scrip and not in cash. And although the present period of reaction dates back but a little way the company has been already obliged to the issue of short term notes.

In matters of railroad policy the Erie has accordingly been conservative. In 1898 it acquired control of the New York, Susquehanna & Western, from New York City to Wilkesbarre in northeast Pennsylvania. Three years later it bought the entire stock of the Pennsylvania Coal Company in order to protect its tonnage, and, as the directors expressed it, for other reasons which seemed good; and in 1901 also it bought an interest in the Lehigh Valley. The most sensational episode which has occurred has been the purchase and subsequent release of the Cincinnati, Hamilton & Dayton. It seems that in 1905 Mr. J. P. Morgan bought a majority of a syndicate’s holdings in Cincinnati, Hamilton & Dayton stock, amounting to a majority of the total issue; a purchase which carried control of the Pere Marquette and of the Chicago, Cincinnati & Louisville, or of a total system of 3675 miles. This stock Mr. Morgan turned over to the Erie at a price reported to be $160 a share. From a traffic point of view the deal seemed likely to strengthen the Erie’s position in Ohio, Indiana, and Michigan, while more than doubling the mileage of its system. Because of the financial condition of the new companies, however, the purchase was decidedly unwise; and, after an investigation, Mr. Morgan’s offer to take the road off the Erie’s hands was gladly accepted. On December 4, 1905, Mr. Judson Harmon was appointed receiver of the Cincinnati, Hamilton & Dayton and of the Pere Marquette, and the reorganization of these properties is just being completed.

At present the Erie is operating 2169 miles of road as against 2166 in 1896. Its earnings have greatly increased, its capitalization has grown in less proportion,154 but it has not yet a sufficient margin of surplus earnings to meet a decline in prosperity without serious misgivings. Dividends on its first preferred stock have been paid since 1901, and on its second preferred since 1905. The common stock cannot expect a dividend in any period which can be foreseen.

CHAPTER III
PHILADELPHIA & READING

Early history—Purchase of coal lands—Funding of floating debt—Failure—Struggles between Gowen and his opponents—Reorganization—Second failure and reorganization.

The Philadelphia & Reading Railroad has been peculiarly unfortunate. Although serving a region of abundant traffic, it failed three times between 1880 and 1895, and was in the hands of receivers ten years. It was reorganized after each failure, and each reorganization was marked by bitter struggles between contending parties, due in part to divergence in financial interests, and in part to personal rivalries.

In 1833 the Philadelphia & Reading Railroad was chartered by the Legislature of Pennsylvania to build a road from Philadelphia to Reading, a distance of 58 miles. Its early history does not concern us. In 1862 it leased, owned, and operated 437.4 miles of track, equivalent, roughly, to 119.4 miles of line; and derived $2,879,419 out of its gross earnings of $3,911,830 from the carriage of coal. Its capitalization was extremely high, roughly, $193,417 per mile of line,155 and the necessary payments each year, not including dividends, took up $1,454,635. At this time the road owned no coal lands, but, like the Lehigh Valley Railroad and the Schuylkill Canal, remained a common carrier, and relied upon the advantages of its position in respect to the Southern coal fields to secure the tonnage which it required.

From 1862 to 1865 inclusive the Reading enjoyed a period of extreme prosperity. The Navy Department, during the war, required large quantities of fuel, and in the revival of business after the conclusion of peace the Reading took its part. Merchandise earnings increased from $523,416 in 1862 to $1,165,277 in 1865; coal earnings from $2,879,419 to $8,627,292; and though expenses also increased, yet net earnings grew from $2,375,247 to $5,236,655, and the balance of earnings, after all charges had been paid, from $920,612 to $2,632,566. Dividends meanwhile ranged from 14 per cent on the preferred stock in 1862 to 10 per cent on both preferred and common in 1866, though the majority of the distributions were made in stock. On the whole, during the Civil War and for a whole year afterwards, the Reading was able to carry without difficulty the burden of an enormous capitalization. What increase in capital occurred at this time was in stock, and did not add to the load, although the desire to pay dividends on the increased stock led to the piling up of new issues.

In 1869 an entirely new departure in Reading policy occurred. Whereas the road had previously owned no coal lands, with the advent of Mr. F. B. Gowen to the presidency it began to purchase on an enormous scale. “The repeated and serious interruptions of the business of the company,” said the annual report for 1871, “caused by strikers in the coal regions during the last few years, and the many fluctuations in the coal trade, produced by alternate periods of expansion and depression resulting therefrom, have attracted the attention of the managers of the company to the necessity of exercising some control over the production of coal, so as to prevent a recurrence of the difficulties heretofore experienced; and it was believed that the best way to accomplish this result, without injuriously affecting individual interests, was for the company to become the owner of coal lands situate upon the line of its several branches.”156 Further, it was felt that some steps were necessary to retain for the Reading even the coal tonnage which it enjoyed. In 1871 every rival carrier had invested large sums in coal properties, and all the fields but the Schuylkill and Mahanoy (western middle) were occupied, while carriers had begun to enter the Mahanoy district, and it was reported to be their intention to build lines straight through to the Schuylkill fields.

The anthracite coal regions of Pennsylvania lie in four main districts: the Northern or Wyoming; the Southern or Schuylkill; and two smaller intermediate fields known respectively as the Eastern Middle or Lehigh region and the Western Middle or Mahanoy and Shamokin basins. The Northern field is the more easily worked, and the Southern field is the richer.157 Between 1869 and 1881 the Reading Railroad and its alter ego, the Coal & Iron Company, formed for the purpose, spent $73,326,668 for lands in the Schuylkill and Western Middle districts, securing 142 square miles, or 60 per cent of all the anthracite lands of these districts, and 30 per cent of all in Pennsylvania. Of the purchase money $69,816,204 were supplied either by the Railroad Company or by sale of Coal & Iron Company bonds which the Railroad Company guaranteed. The Coal & Iron Company incurred non-guaranteed liabilities for the rest.158 This gave ample resources for the permanent supply of coal tonnage to the railroad, and was sufficient also to give a considerable measure of control over production in the Southern district. Independent operators did continue, however, and the Reading coal was subject to the competition of coal from other fields. More important still, in attaining control, “all kinds of coal properties, good, bad, and indifferent, were purchased without regard to original cost, location, or revenue producing capacity.”159 In 1880 an engineer of reputation was appointed to evaluate the Reading coal lands, and recommended the surrender of five properties that originally cost $5,207,167, upon which there were encumbrances of $5,015,000. “But little weight,” said he, “should be given to the fear that rivals will possess the surrendered property; most of it is not a tempting investment.” Exorbitant prices were paid for the lands purchased. By 1881, as noted, there had been expended in all by the two Reading companies $73,326,668. This same report said that, “assuming the profit on the future coal product to be 30 cents per ton of coal shipped, that the company will be able to reduce the rate of interest on the money needed to hold and develop the property from 7 per cent to 6 per cent per annum, and that the development will be at the rate just stated [outlined earlier in the report], the whole estate has a value of $32,394,799: the company’s interest in the estate is worth $30,630,648, and, including colliery improvements belonging to the company, but situate on lands owned by others, the whole of the company’s property is worth $31,197,484.”160

It is unquestionable that the Reading did acquire an enormously valuable property in the decade succeeding 1870. It seems just as clear that it paid more for this than was necessary; but what is perhaps more to the point is the fact that the Reading paid more than it could afford. Whatever the ultimate advantages to be gained by exclusive possession of any considerable section of the coal fields, the Reading was not large enough nor financially strong enough to make such vast purchases within so short a space of time. The prosperity of the Civil War had disappeared, net profits were fluctuating without marked tendency to increase, the figures for 1870 being actually less than those of 1863, while the interest on bonds had more than doubled since 1867, and the sum required for dividends had increased. To advance $54,886,647 to the Coal & Iron Company under these conditions, and to become responsible as guarantor for $14,929,557 more, would have been ill-advised even had the prices paid by the company been in strict accord with the commercial estimate of the time. Under the best of circumstances returns from much of the property acquired could not be secured for many years. The parts of the coal fields which were worked yielded an income, though it was seldom that the collieries were allowed to run to their full capacity; but those districts which were bought for the sake of controlling the coal situation, or in order to secure a future reserve, and which in many cases could not be worked at existing prices, occasioned a drain upon the company to the amount of interest on the purchase money, with no return of any kind. Moreover, the purchase of the coal lands put the Reading in the anomalous position of a railroad corporation interested in industrial lines. It could no longer be content with encouraging the transportation of its main source of revenue (coal), but had to care as well for the price at which this coal was sold. When depression in the coal trade came, the Reading lost both as producer and as carrier, for less was transported, and that amount was sold at a lower price; but when good times came, from which as a simple carrier it might have profited largely, it struggled with conditions of over-production which should rightly have been none of its concern. There was, finally, a peculiar fatality in the time which the Reading chose for its expansion. The year 1873 will always be remembered as one of the most disastrous in the history of the United States. Commencing with the failure of Messrs. Jay Cooke & Co. on the 18th of September, the panic spread with such rapidity as to lead to the closing of the New York Stock Exchange on September 30. All railroad securities were exceedingly depressed, call loans were high, and it was nearly impossible to secure new capital. Business the next five years was very dull, and the Reading actually earned less gross in 1879 than in the year before the panic, and this at the very time that its liabilities were so largely extended. The natural result was the financial difficulty which can be detected as early as 1876. In June it appears that, owing “to the continued depression in the iron and coal trades and the consequent falling off in transportation,” the road was obliged to reduce its working force. In July the usual dividend was passed; salaries were lowered in September, and still later a temporary loan was secured to tide over the floating debt, which then amounted to $8,272,359. By the next year the matter had become serious enough to necessitate a formal proposition to creditors for the postponement of interest payments and of payments on the floating debt. The company professed itself able to carry out the following:

(a) To pay the interest on prior liens in full.

(b) To pay one-half the interest on the general mortgage bonds and on the Perkiomen sterling mortgage bonds for three years in cash, and one-half in five-year interest-bearing scrip, with the option to the holder of receiving instead scrip for the three coupons first maturing and cash for the rest.

(c) To pay for five years in scrip the interest on the debenture bonds of both the Railroad and Coal & Iron Companies; the convertible bonds of the Railroad Company, the bonds due in 1885, 1902, and 1918 of the Tidewater & Susquehanna Canal Company, and so much of the rent due to the Schuylkill Navigation Company as was applicable to the payment of dividends to stockholders of the Company and to the interest upon its mortgage loan of 1895.

(d) To suspend the drawings for the payments of sinking funds and of the improvement and general mortgage bonds for a period not exceeding four years, if so long a time should be required for the payment of the floating debt.161

“The relief to be obtained from the above,” said President Gowen, “will undoubtedly enable the managers, even with no improvement in traffic or increase of rates, to meet the fixed charges on all obligations of both companies other than those above named, and to pay off the entire floating debt within such time as will be satisfactory to the holders thereof.” Certain modifications were suggested by the London securityholders, providing for trustees with some power to protect the creditors,162 and the plan went quietly into effect.

From now on matters went from bad to worse. The year 1878 showed a falling off in almost every source of revenue, while expenses and charges remained very nearly the same. Depression in the coal trade and connection with the Coal & Iron Company, general dulness of business after 1873, troubles with employees, over-capitalization, all had their share in pushing the company still further into the mire. It became unable to keep its share of the existing business, and the percentages of the Schuylkill output carried by it steadily decreased from 83.49 in 1877 to 75.45 in 1881, while its percentage of the aggregate output from all the anthracite region diminished from 32.82 to 24.44. “It appears, therefore,” said the annual report for 1881, “that while other companies have steadily increased their capacity of production by regular and judicious expenditures for new openings, breakers, machinery, and other facilities for mining and delivering coal, the Reading Company has apparently remained stationary.... For this policy the local officers in charge are not probably responsible, as it was undoubtedly forced upon them by the management, because of the impoverished and embarrassed condition of the company’s finances.”163

Throughout 1879 there was trouble over the payment of wages, perhaps as good a sign of financial difficulty as can be desired. Employees were paid in scrip, not cash, and even scrip wages were left overdue. President Gowen went to Europe toward the middle of the year, but not at all, as he carefully explained, in order to place a new loan, or to transact any business except a little in relation to some railroads for the company; in fact, the condition of the Reading was an open secret, and new loans were impossible to obtain. In May, 1880, the New York and Philadelphia banks began to refuse further accommodations. At the same time the period during which, according to the agreement of 1877, cash payment of general mortgage coupons was suspended, drew to a close, and on May 21 the Philadelphia & Reading announced its inability to meet its obligations. As was said at the time, the company did not fall with a crash because it had not far to fall.

The failure occurred on May 21, and on May 24 Messrs. F. B. Gowen (president of the company), Edwin A. Lewis, and Stephen A. Caldwell were appointed receivers. Their resources were scanty and they had to do with them as best they could. On the one hand they applied to the court for authority to borrow $1,000,000 to pay the wages of employees and interest falling due July 1, and on the other they cut down expenses by reducing the working force in the repair shops, by putting the shops on short time, by discontinuing many of the trains on different lines, and by ceasing all dead work at the collieries.

Before any plan could be proposed for the rehabilitation of the company the condition of its finances had to be known, and this again the receivers took in charge. Their report in June, 1880, showed a sufficiently serious state of affairs. The floating debt of the Railroad Company had mounted up to $10,254,766, besides $1,900,482 more for the Coal & Iron Company. This represented an increase of $3,604,000 as compared with November 30, 1879, and an English bondholders’ committee declared that only $2,930,000 of it were represented by value.164 The rest had apparently been incurred in desperate attempts to preserve the solvency of the company. The total liabilities of the Railroad and Coal & Iron Companies, including mortgage, debenture debt, floating debt, and miscellaneous items, but excluding stock, were $152,436,890. The deduction from these figures of the Coal & Iron bonds held by the Railroad Company, which would have constituted a duplication of indebtedness, left a total of $106,215,830.

The stock of the two companies amounted to $42,278,175, and the stock in the hands of the public to $39,278,175. The grand total of liabilities was thus the enormous sum of $145,494,005. The charges for interest and sinking funds were $7,542,094, and the annual payment of $5,629,764, due on $87,558,482 of railroad bonded indebtedness, shows that the rate of interest upon the bonds was high. The net revenue was $5,494,979, and there was therefore a deficit of $2,047,115. Meanwhile the Coal & Iron Company had reported a regular deficit up to 1880, which, though not significant in itself, because of close relations with the Railroad Company and the impossibility of determining how much the Coal Company’s rightful profits were reduced by exorbitant transportation rates, yet made it very clear that from this source the Railroad Company could expect no aid toward the cancellation of the railroad deficit revealed.

The combined companies were unable to earn their fixed charges: the continuation of the struggle to do so was sure to mean, as it had in the past, merely a piling up of the floating debt. The coupon-funding scheme of 1877 had shown the inevitable result of temporary measures of relief; and though business in 1880 was rapidly improving, there was need for a radical reduction in the burden resting upon the company. Pending action, a bill for foreclosure was introduced under the general mortgage of 1874.165 A valuation of the Reading coal properties, to which reference has already been made, was started. It was entrusted at first to Mr. S. B. Whitney, chief engineer of the Coal & Iron Company, and to Mr. Frank Carver, the land agent; but was later given over to Mr. Joseph S. Harris, chief engineer of the Lehigh Coal & Navigation Company, in order to have the opinion of an unprejudiced expert.166

The first suggestion for a plan of reorganization came from England. The consolidated mortgage, prior to the general mortgage, was to be foreclosed; general mortgage bonds were to be deprived of their right to sue or to foreclose; all unsecured bonds and junior mortgages were to be exchanged for preferred stock; and a $15 assessment was to be levied upon the stock, for which collateral trust 7 per cent bonds were to be given. This assessment was relied on to pay off the floating debt, and the new company was to start free, with but $33,564,000 of mortgage indebtedness.167

This plan was a step in the right direction. It recognized the validity of prior liens, followed a sound principle in providing for the floating debt by assessments upon the stock, and relieved the company from the likelihood of a future failure by its treatment of the general mortgage bonds; but it was weak in that it reduced the general mortgage to the anomalous position of a bond entitled to a fixed return without the power to enforce it. Stockholders, moreover, objected strenuously to the assessment, maintaining that business conditions were now such as to make milder measures sufficient.

In October, 1880, Mr. J. W. Jones, formerly vice-president of the Reading Company, urged that an assessment on the stock was not necessary, and proposed the following:

(1) To convert the income, debenture, and convertible bonds and scrip into second preferred stock bearing 5 per cent interest if earned;

(2) To issue $15,000,000 of first preferred stock, with which to retire the floating debt;

(3) To scale the Coal Company mortgage bonds $200,000 per annum, which could possibly be done by consent of holders, if not, then by foreclosure.168

The main difference between this and the English scheme lay in the treatment of the floating debt. It is improbable, however, that the substitute which this plan offered would have been sufficient, and that the preferred stock could have brought $66, at which price alone it would have covered the floating debt. Reading common stock was selling in the middle of the month at 16⅜; general mortgage 6s were bringing only 74¼, while debentures and convertible 7s were being quoted at 28 and 37 respectively.

In October a representative of the English bondholders arrived in Philadelphia for the purpose of examining into the condition of the company, and the following month agreed with the board of managers upon a reorganization committee to act in the United States. “The probabilities are,” said this gentleman (Mr. Thomas Wilde Powell), “that it will be found that the bondholders in London will be willing to do as they did in the case of the Erie, that is, fund a reasonable number of coupons ... for the purpose of setting at liberty a portion of the revenue to pay unfunded claims.”169 The next move in the reorganization of the company came, however, not from this committee but from President Gowen, the man who had led the Reading into the purchase of coal lands, and who still remained in office in spite of the hostility shown toward him. His scheme comprised two parts: the first an issue of income bonds with which to pay off the floating debt (together with $5,000,000 mortgage bonds); the second a grand general mortgage to retire existing indebtedness. The plan in more detail was as follows:

(1) The company was to create $34,300,000 deferred income bonds, on which interest was to be deferred to a dividend of 6 per cent on the common stock. After this amount had been paid the bonds were to take all revenue up to 6 per cent and were then to rank pari passu with the common shares for further dividends. The debentures were to be issued at 30 per cent of their par value, or $15 per bond; and before selling or disposing of said bonds in the market the option of taking a pro rata share was to be first offered to the stockholders of the company.170

(2) A more permanent relief for the company was to be obtained from the proposal to issue a new long time or perpetual 5 per cent funding mortgage of $150,000,000, divided into two classes, A and B, of $75,000,000 each: class A having priority of lien and interest charge over class B. With this issue it was proposed, by purchase or exchange, to retire all outstanding indebtedness, and to acquire by purchase the securities of the companies owning the leased lines. It was estimated that $140,000,000 of the new issue would provide for all of this, the total interest on which would be $7,000,000, as against fixed charges for interest, sinking funds, and rentals, of $10,657,116, making an annual saving of $3,657,116.171 Mr. Gowen did not expect to secure so large an annual reduction, owing to the impossibility of purchasing the higher securities and the probable appreciation in value of the lower ones; but he did expect to realize in all a saving of some $2,700,000.

In part this plan was commendable; in part it was inadequate, and in part it relied on a mere juggling with words. The proposal to unify all classes of indebtedness by a grand consolidated 5 per cent mortgage was a good one, both in the simplification of accounts which was to be expected, and in the reduction in fixed charges so far as this reduction went; but on the one hand a reduction of $2,700,000 in charges was too little for a company which had reported for that very year a deficit of $2,000,000, and on the other hand too little allowance was made for the difficulty of forcing securityholders without a foreclosure sale to submit to a definitive scaling down of their holdings, with not even a preferred stock to show for the sacrifice. In its handling of the floating debt, the plan was a second edition of Mr. Jones’s stock-selling scheme, with all the good points left out. What justification there could have been for calling securities, such as the deferred incomes, “bonds,” which were to be issued for no definite time, ranked even after the common stock for dividends, and were of such doubtful character that Mr. Gowen himself proposed to sell them for one-third of their face value, does not appear; unless it be that the lack of voting power, itself a disadvantage, entitled them to the more respected name. The deferred income bonds were a device for saddling the holders of the unsecured debt with a worthless certificate which they might be induced to accept because of its name, and to which not even the Reading stockholders could object. Furthermore, even if the creditors had been eager for this new issue, in itself it would not have been sufficient. The issue, if taken up, would have yielded $10,200,000. It was proposed besides to sell $5,000,000 of unissued general mortgage bonds, which, after the success of the deferred income bonds, it was presumed would sell at par. Income bonds and general mortgage together promised a total of $15,200,000, or more than $1,000,000 over cash requirements after commissions had been paid.172

However poor the prospect, there was no lack of syndicate guarantee. In November, 1880, a London syndicate agreed to deposit with an American bank, to be named by the company, the sum of $2,058,000, to be forfeited in case they failed to take at the issue price all deferred income bonds not taken by the shareholders. This syndicate further agreed that the company might retain, up to $1,000,000, out of the deposit money, whatever might be necessary to make up a second instalment of $4 on such neglected bonds.173 Nothing was asked from the company in return except the chance to sell the bonds purchased at a premium. “As long as the bond- and shareholders find the money,” remarked the London Times, “there is nothing to be said. In all probability, however, these deferred bonds will become a medium for the very worst kind of gambling, and their chances for a dividend appear to us to be very small.”174

In December Mr. Gowen’s plan received the approval of the American committee and of the board of managers of the company. Bondholders were in no way injured by the worthlessness of the deferred income bonds, and only the most far-sighted could be expected to have demanded a larger reduction in their claims. The same month a meeting of London bond- and shareholders passed unanimously a resolution expressing confidence in President Gowen, and adopting his scheme.175 Opposition came from the influential London banking firm of McCalmont Bros., and the struggle centred about the annual election set for January 10, 1881. The last of November or first of December President Gowen issued a circular in which he said: “As I am about to visit Europe on business of the company, and as it is possible that I may not return until the first week in January, I think it proper to call your attention to the fact that it is highly important that all shareholders who can possibly do so should attend the annual meeting in Philadelphia on the second Monday in January. An effort will undoubtedly be made at the next election to control the management of the company in the interest of rival lines, and if the effort is successful the future of the Philadelphia & Reading Railroad Company will be little, if any, better than that of the Philadelphia & Erie Railroad Company, or of the Northern Central Railroad Company.”176 In Europe, or, more strictly speaking, in London, Gowen busied himself in placing his deferred income bonds, with apparently a very considerable measure of success. As to the result of the coming election he professed absolute confidence. It made little difference, said he, which way the McCalmonts decided to vote their shares. He could be elected without any English votes at all, and with the backing of the English bondholders who had resolved to support him, the matter was not at all in doubt.177 On January 4, six days before the date set for the election, Gowen actually issued a prospectus for his new income and mortgage loans, and cabled to Vice-President Keim that he was satisfied that he could dispose of the general mortgage A bonds at 110 and the general mortgage B bonds at par.178

Meanwhile in America both parties had recourse to the courts: the McCalmonts, to prevent the issue of the deferred income bonds, and the friends of Mr. Gowen to get the election postponed in order to give the president time to return from Europe. The latter suit was the first decided. Judge McKennan, of the United States Circuit Court, refused to grant an order, but unofficially advised postponement. The board of managers therefore withdrew the notice of the annual meeting, and on January 12 voted to postpone it indefinitely. Counsel for the McCalmonts then made application to the Court of Common Pleas in Philadelphia for a mandamus to compel the board to call a meeting. They obtained a peremptory mandamus on January 24, but accepted the date of March 14 as satisfactory, and forbore further proceedings.

The matter of the deferred income bonds was complicated by a full and complete authorization which Mr. Gowen had before obtained from the Circuit Court for the issue of his bonds. The request of the McCalmonts was twofold: the court was prayed to revoke the previous decree, and to enjoin any further action in the negotiation or consummation of the said scheme; or, failing this, to direct the officers of the company and the receivers to refrain from the issue of the bonds until the form thereof should have been settled by the said court, and also until deposit with the receivers should have been made of the $2,058,000 provided as a guarantee.179 The first request sought a prohibition of the issue; the second attempted to delay the negotiation of the bonds until the annual election should have passed and the McCalmonts should have had a chance to obtain control. The immediate result was the transference to Philadelphia of the $2,058,000 guaranteed, from its place of deposit in London. In February the McCalmonts obtained a revocation of the original grant of authority for the deferred income bonds, a continuance of the suit for a preliminary injunction, and an order restraining the respondents from “making any agreement or ordering any act by which the Philadelphia & Reading Railroad Company [might] be definitely bound touching the deferred bond plan or the proposed mortgage loan of $150,000,000.”180

In January the Coal & Iron Company quietly held its annual election, and chose Mr. Gowen president. As the time for the postponed election of the Railroad Company came round, the activity of both sides became intense. Both Gowen, who was still in London, and the McCalmonts issued calls for proxies. The former appealed to the shareholders to save the property from passing into the hands of the Pennsylvania Central Railroad Company, which he said was believed to be the ruling power behind the McCalmont litigation. The latter objected vigorously to this charge, and pointed out that the Reading managers held only 16,500 shares of the company’s stock, and that some of them had barely enough to qualify them for the positions which they held.181 The McCalmonts, furthermore, applied to the courts for an injunction to prevent Gowen from voting on the shares pledged as collateral for the floating debt. They maintained with some justification that these shares could not legally be voted, and that it was particularly illegal for the president to use them to elect himself.182

On March 12 the Court of Common Pleas issued a decree regulating the conditions under which the election should be held, providing for the separate count of votes of shares transferred three months before the election, and for the ultimate reference of all disputed points to the Court. By this time Mr. Gowen had become alarmed at the apparent strength of the McCalmonts, and had come to realize that a possible disenfranchisement of a part of his own holdings on the ground of too recent transference might lessen his chances of retaining control. He recalled, however, that the annual meeting had been postponed from January 10 to March 7, and finally to March 14. This, it occurred to him, might transform it from a regular to a special meeting, and might, according to the terms of the company’s charter, make necessary the presence and vote of a majority of all the shares outstanding, instead of a simple majority of all the shares on hand. If this should be true a disenfranchisement of his holdings would be of less importance; for whether disenfranchised or not, these would form part of the total shares outstanding, of which an absolute majority would be required.

On March 12, two days before the appointed date, Mr. Gowen issued a letter to the shareholders. “I hold,” said he, “up to the present time, the proxies of 1921 shareholders of the company, owning 359,500 shares of the capital stock, being very considerably more than a majority of all the shares.... Of the shares for which I hold proxies, so large a proportion, however, may possibly be disenfranchised by failure to register, that if the legal meeting of the stockholders is held on Monday next, and it should subsequently be determined by the Court that three months’ prior registry is essential to confer the right of voting, it may be possible that the wishes of the great majority of bona fide shareholders may be overruled by a minority.... I have determined to abstain from attending the meeting, and I earnestly request all shareholders who support the present management to absent themselves from the meeting on Monday, and thus to give legal effect to their wishes by making it impossible for the minority to secure the attendance of a quorum....”183

Mr. Gowen’s friends, English and American, followed his suggestion; and at the meeting on Monday but 211,095 out of 687,663 registered shares appeared to vote. The immediate result was the almost unanimous election of Mr. Bond, the candidate of the McCalmonts, which was followed by litigation on the part of Mr. Gowen, disputing the legality of the election. By the terms of the decree under which the election had been held, the matter came first before the Court of Common Pleas, which, on April 9, decided that the meeting had been a legal one, and that the officers then voted for by the McCalmonts had been duly elected. With the above court ranged against him, Mr. Gowen took appeal to the Supreme Court of the state, and meanwhile declined to surrender his position. On April 11 the new board proceeded to the Reading offices in Philadelphia, made formal demand for admittance, and were refused. On April 22 President Bond issued formal notice of his election. An injunction was asked against Mr. Gowen, but was held back until the Supreme Court should have taken action. Meanwhile the old board of managers announced that if a decree supporting the decision of the Court of Common Pleas should be rendered they would make no further opposition; and the transfer agents of the company in Philadelphia and New York refused to transfer any stock until the dispute should have been settled. On April 19 an order of the United States Court interfered with Mr. Gowen’s exclusive possession, and compelled him to furnish to Messrs. Frank S. Bond, etc., suitable accommodations in the offices of the Philadelphia & Reading Railroad Company, with free access to all books and papers. In May the Supreme Court rendered its decision, holding the meeting of March 14 to have been a regular meeting, and a majority of all the stock outstanding not to have been required for a quorum. Gowen asked for a rehearing, which was denied, and in June, nearly four months after the election, he grudgingly acknowledged Mr. Bond and his associates as the legally elected president and board of managers.

During all this time the deferred income bond scheme had not remained untouched. In April, 1881, on application of the McCalmonts, the United States Circuit Court at Philadelphia had granted a preliminary injunction against it. “Whatever power the defendant has in the premises can only be found in the general authority to borrow money,” said Judge McKennan, and went on to state that the issue did not constitute a loan, because a loan implied reimbursement, and the income bonds were redeemable at no special time.184 Mr. Gowen promptly proposed to make them redeemable, and insisted that this made them still more desirable. A week later the $150,000,000 general mortgage was also enjoined.185

Once out of the presidency Mr. Gowen endeavored to induce the McCalmonts to accept his plan. If they would adopt the deferred income bond scheme, he said in an address to shareholders, he would resign the receivership of the road at once, give bonds never to stand for the presidency again, and further coöperate with them in selecting a new board of directors. As an alternative he offered to buy the McCalmont shares at $40 each, and threatened to beat that party at the next election if it refused.186 In September he assured the stockholders that he could without difficulty put the road upon its feet. “If Bond and his colleagues will resign and reinstate the old management,” he cabled from London, “and advise me by cable of the change, I can, before sailing on Saturday, procure sufficient advances against the proceeds of preferred [deferred?] income bonds and new 5 per cent consols to pay the floating debt, receivers’ certificates, and all arrears of interest.”187 Finally, appealing to Mr. Bond direct, Gowen made formal application that the new board should adopt his plan after changing the form of the proposed obligations by making them payable in 100 or 200 years.188 Bond refused. He pointed out that the deferred income bondholders would be in constant conflict with the management in their endeavor to secure dividends on their holdings, and would attempt to prevent proper and necessary expenditures upon the property from current net revenues. He declared that it was questionable whether the company had authority to sell its unsecured obligations below par, and that in any case the process would be enormously expensive; and, further, that the language of the obligation did not limit the payment of interest to the source of net revenue only, but might be construed to compel the declaration of 6 per cent on the income bonds whenever 6 per cent should be paid on the common stock.189 Failing in his attempts to win over his opponents, Gowen turned his energies toward securing their defeat.

Meanwhile President Bond brought forward a plan of his own. He had grasped three points of weakness in Gowen’s scheme, namely,—

(1) The issue of a mass of worthless obligations in the deferred income bonds;

(2) The high level of fixed charges which a $150,000,000 5 per cent mortgage entailed;

(3) The lack of any security which had a right to interest only when earned, and which might be given to the bondholders in return for sacrifices which they would otherwise refuse to make.

He proposed, therefore, to create a general consolidated mortgage to cover all the property of the Reading Railroad and Coal & Iron Companies, together with the interest of both companies in all other corporations and property, whether owned or controlled by lease or otherwise. This mortgage was to be junior to the consolidated and to the improvement mortgages only, but was to contain a provision by which, as bonds under these senior mortgages should be retired, additional bonds might be issued under the new mortgage, which was eventually to become a first lien upon all the properties of both companies.190 The total was to be $150,000,000, to be divided into two series: of which series A, for $90,000,000, was to run for fifty years, and was to have a prior lien over series B upon the revenues for interest at the rate of 4½ per cent, with a right to enforce foreclosure in case of a twelve months’ default; and series B was to run sixty years, and was to carry interest at 3 per cent, with a right to enforce foreclosure in case of a three years’ default. In prosperous years series B might receive more than 3 per cent: thus the mortgage provided that from current net revenue applicable to dividends it should get 1½ per cent additional interest before any dividend should be paid on the stock of the company; after that 3 per cent might be paid on the capital stock, and then 1½ per cent additional might be paid on series B; it being understood that the interest in excess of 3 per cent should not be cumulative, but was to be paid only from current net revenues of the company otherwise applicable to dividends. These two issues of unequal worth were to be used for different purposes. Series A was to be in part reserved to retire the senior obligations, and in part to be sold to pay off the general mortgage bonds, the general mortgage scrip, the income bonds, the floating debt of the Railroad and Coal & Iron Companies secured by collateral, the receivers’ obligations, and the mortgages on real estate that could be paid off. Series B was to be exchanged for the junior obligations, such as the debenture or convertible loans, or was to be held in reserve for subsequent acquisition of the guaranteed stock or obligations of affiliated corporations of the Railroad and Coal & Iron Companies.

What this meant for the immediate future was that all prior liens were to remain untouched, while everything from the general mortgage down was to be funded into the new obligations. In some ways this resembled the earlier scheme of Mr. Gowen, since in each case there was to be a $150,000,000 general mortgage in two parts, of which one part was to have priority over the other, and in each case this grand mortgage was to be used ultimately to retire all previously existing indebtedness. An innovation was now made, however, in the difference introduced between the two series. In Gowen’s scheme the amount of each series was to be the same, and each was to fare alike, except for the priority of series A; in that of President Bond, series A was to be half again as large as series B, and was to bear a higher rate of compulsory interest; although, a point of extreme importance, the return upon series B was to run from a minimum of 3 per cent to a maximum of 6 per cent whenever the road should earn it. Thus President Bond gained two things: he reduced the rate of interest which his new bonds could claim in any year from 5 per cent (as under Gowen’s scheme) to an average of something under 4 per cent, which would yet, in prosperous times, net them as much as the old bonds surrendered; and as a still further concession, he gave to the 3 per cent bonds a term of sixty instead of fifty years, raising their value to that extent. As the various existing issues of bonds had different market values, he thought it proper to equalize these values in the exchange by the grant of a bonus in stock, for which the capital stock of the company was to be increased one-third. Here were two of Gowen’s problems in a fair way of solution: the reduction of fixed charges was accomplished, while some incentive was given to the junior bondholders to assent. Scarcely less from the point of view of sound finance was the gain from the abandonment of the anomalous deferred income bond scheme, with its $34,300,000 of worthless speculative securities. Instead, the floating debt, under President Bond’s plan, was to be cared for by the sale of series A bonds, not at one-third their face value, but as near par as possible; by the best of the company’s new securities, in other words, and not by the worst. And, finally, the acquisition of the securities of subsidiary roads was provided for rather ingeniously by the conversion into series B bonds of $10,527,900 convertible 7 per cent bonds, against which had perforce been reserved an equal amount of stock. Conversion released the stock, which became a free asset available for any uses to which the company saw fit to apply it.

Yet while the advance which the plan of President Bond marks over that of President Gowen may be recognized, its defects must also be observed. It was, in the first place, in common with all other schemes suggested, too mild, too little drastic in its operations. The condition of the Reading companies was desperate in the extreme. By President Bond’s own figures the previous five years had shown a deficit of $11,479,217, or an average loss per annum of $2,295,853. The net earnings for 1881 by the same computation had been $8,418,009, and the fixed charges $11,265,666.191 What was needed was a radical scaling down of indebtedness, to take effect not in the far distant future but at once. President Gowen, face to face with a similar situation, had evolved a reduction in fixed charges from about $11,000,000 to about $7,000,000, but had explained that, owing to the impossibility of retiring all of the prior liens at once, the actual figures would be approximately $7,957,000. President Bond, less optimistic, or more honest, stated that the ultimate charge under his plan would be about $6,000,000; but that the immediate reduction would be to about $8,339,000 only, scarcely more than $100,000 below the net earnings of the current year. Both estimates would probably have been under the mark; but the relief which President Bond proposed was utterly inadequate even on his own showing. A margin of surplus earnings which could be wiped out in a single month was no answer to the demand for a restoration of the Reading companies to solvency. In regard to the floating debt, too, Bond’s plan left something to be desired, in that it provided for no assessment, but cared for the floating obligations by the sale of bonds. The danger in relying upon the sale of securities to supply the cash requirements of a bankrupt road has been mentioned in connection with Mr. Gowen’s scheme, as indeed at other times before. At best it is advisable only in prosperous times, and when the bonds offered are of high grade; and though the series A bonds might perhaps have been considered high grade, the prosperity of 1880 was not repeated in 1881, and a year of bankruptcy and litigation had not improved the Reading’s credit. That the plan failed, however, was due neither to its inadequacy nor to its method of dealing with the floating debt; but rather to the resolute and uncompromising opposition of Mr. Gowen and his friends, and to the determination of the junior securityholders to stand out for better terms. This twofold resistance caused a syndicate of bankers, which had been relied upon to place the new loan, ultimately to reject it, and the plan fell through.192

To return now to Mr. Gowen. This gentleman had been strengthening his following in every possible way, and had secured one ally of particular importance in the person of Mr. Vanderbilt, who in October, 1881, was reported to be buying largely of the company’s stock. Early in November Mr. Gowen and President Bond both issued addresses to the shareholders. The former maintained that although the present management had been in power for over four months it had done nothing to extricate the company from its difficulties, and promised that if elected he would “retain the office long enough to place the company in a good financial condition, by completing the issue of deferred income bonds and by issuing and selling the 5 per cent consolidated mortgage bonds, the result of which will be the resumption of dividends upon the company’s shares.”193 The business prospects of the company were never better, he continued, and the wisdom of the purchase of the great anthracite coal estate was being demonstrated. Bond, on the other hand, alluded to the failure of Mr. Gowen’s many promises, to the wasteful expenditure of money, to the coal speculations in which the road had been engaged, to the payment of unearned dividends, and to other points of Gowen’s policy, actual or alleged;194 and his statements were repeated by the McCalmonts in spite of Mr. Gowen’s vehement denials.195

The election was held from January 9 to January 14, 1882. There were cast 493,601 votes, of which Gowen received 270,984 and Bond 222,617; a result mainly due to the 72,000 Vanderbilt shares voted for Mr. Gowen. The same meeting approved by resolution Gowen’s financial plans, and called on the incoming board of managers to carry them into effect. To clear the way a test suit was brought in the Supreme Court of the state of Pennsylvania, and a close decision obtained favoring the issue.196 Counsel for the McCalmont Bros. petitioned in the Circuit Court for leave to withdraw their complaint, stating that the McCalmonts had disposed of almost all their holdings, and the Circuit Court vacated the injunction which it had previously granted.197

Gowen’s plan was now triumphantly brought forward, with the few alterations which time had suggested. There was to be as before a deferred income bond issue of $34,300,000, which was to retire the floating debt; the general mortgage was to be increased in amount from $150,000,000 to $160,000,000, but was still to be divided into two series, equal in amount, and differing in privileges only on the point of priority of lien; of which series A was ultimately to exchange for the senior, series B for the junior obligations of the company. $13,500,000 of the first series and $10,000,000 of the second series were to be put out at once, and $4,000,000 convertible adjustment scrip were to be issued to settle back coupons. Time had apparently made more modest Mr. Gowen’s estimate of the saving to be secured; for instead of not more than $7,000,000 as before, he now hoped for fixed charges of not more than $8,000,000; but with undaunted optimism he made up for this admission by glowing pictures of what the company in the future was going to earn. “Net earnings last year” (1881), said he, “were over $10,000,000—in 1882 they may be expected to reach $11,000,000, and they will before long be over $12,000,000. With net earnings of $12,000,000, and fixed charges of $8,000,000, there will remain a dividend fund of $4,000,000, equal to 6 per cent on the share capital, and 6 per cent upon the par, or 20 per cent upon the issue price, of the deferred income bonds. “In order to get the property out of the hands of the receivers an earnest effort was made to sell the $13,500,000 series A bonds of which mention has been made, but at the minimum price of 98 subscriptions for but $723,500 were received, and the company was obliged to have recourse to the $5,000,000 unissued general mortgage 7 per cent bonds, which it fortunately had at its disposal. Even before this the management had been forced to abandon any immediate attempt to retire the old general mortgage bonds,198 and had been compelled to answer inquiries as to the reasons for a decline in the price of the deferred income bonds. On February 28 the receivers of the Railroad and Coal & Iron Companies formally surrendered the control of the property to the officers of those corporations.

One of the first acts of the reconstructed company was the lease for 999 years of the Central Railroad of New Jersey. This road in many ways formed a natural complement to the Reading system. Like it, it was a coal road, carrying something less than half as great a tonnage as the Reading itself, and owning extensive coal lands in the Wyoming region; while in location it supplied the necessary connection between the Reading lines and New York. At a later date Mr. Joseph S. Harris testified that all the business of the Reading coming from the South or Southwest went to New York over the Central; while, on the other hand, business from the Northwest was carried by the Jersey Central from Scranton, where its lines began, to Bethlehem, and was there handed to the Reading for transportation to Philadelphia.199 The advantages of the Central to the Reading were thus enumerated by General Traffic Manager Bell in 1885: “The joint traffic with the Central Railroad, outside of coal, and outside of passengers, adds $1,500,000 to the revenue of the old Reading system. By means of the Lehigh & Susquehanna division of the Central Road we extend from Phillipsburg to Scranton or Green Ridge through the entire Lehigh Valley; that system feeds our North Pennsylvania line; it is our connection for the Catawissa system by way of Tamanend and Tamaqua; it is the connecting link in the cross line or Allentown system; it creates the shortest line from interior Pennsylvania, and from Northwest Pennsylvania to New York waters. Through the operations of the lease we reach the largest slate territory in Pennsylvania, and the largest iron producing furnaces anywhere in this country, with the exception of Pittsburg.”200 In 1883 the Central was bankrupt with no immediate prospect of recovering from its difficulties, and had therefore an incentive to accept any arrangement by which interest on its obligations should be paid; while Mr. Gowen, with misplaced confidence in his scheme of reorganization, was ready to put fresh burdens on his road in the hope of future gain.

Rumors of a lease were abroad in 1882, and after the termination of the Reading receivership the operation was pushed to a speedy conclusion. The Reading undertook to assume all the obligations of the Central, and to pay 6 per cent on its capital stock then outstanding, as well as $18,000 annually for maintaining the corporate organization of the lessor. In case any of the Central bonds should be retired, or rentals or interest reduced, the rental to be paid by the Reading was likewise to be reduced. The roadbed and rolling stock of the Central was to be maintained undiminished, but if the Reading should make any additions or improvements, or if from its own funds it should pay off any of the Central’s obligations, it was to receive equivalent bonds with interest not exceeding 6 per cent from the Central Company. The lease was terminable on 60 days’ notice in case the lessee should fail at any time to carry out its provisions.201 This involved something more than a nominal obligation. The net earnings of the Jersey Central in 1882 had been $5,091,072, while the sum due for rentals, interest, 6 per cent dividends, etc., had mounted up to $5,898,087, not including payments on car trusts or certain contingent obligations. Broadly speaking, the Reading proposed to guarantee 6 per cent on the stock of a road which had failed because unable to meet its fixed charges; and however great the ultimate advantages, it is apparent that the prospect of a drain upon the Reading Company was real. In order to get the road out of receivers’ hands, the Reading had further to take care of a floating debt of $2,062,000, and to compromise with certain creditors by settling back interest on their bonds. This was done, and on May 29, 1883, possession formally passed over. The same day was concluded another arrangement, whereby the Central of New Jersey leased the coal and railroad companies comprised in the Lehigh Coal & Navigation Company for one-third of their gross receipts, and the Philadelphia & Reading Railroad became liable for the faithful execution of the contract. The Reading agreed that the Lehigh coal lands should be developed pari passu with its own, so that the product of the two estates should be constantly as 28 to 72 until the Lehigh production should reach 3,000,000 tons. The rental of the road was not in any year to be less than $1,414,400, nor more than a sum rising from $1,728,700 before 1887 to $1,885,800 from 1887 to 1892, and $2,043,000 after 1892, plus certain minor payments; and there was provision for arbitration of any disputes which might arise.202

The year 1883 now seemed to find the Reading imbued with new life. Earnings increased, both gross and net, fixed charges as reported rose less rapidly, and the net profits for the year, or balance on all operations, showed a threefold increase. “The company,” said Mr. Gowen, “has now surmounted the difficulties of the last four eventful years.”203 The annual meeting in January was a genuine love-feast, marked by the presentation of resolutions highly flattering to Mr. Gowen. “We trust,” said one, “we thankfully appreciate your herculean efforts in our behalf, in the face of unparalleled difficulties and obstacles, in rescuing our property from bankruptcy against the malignant and determined efforts of its enemies and conspirators to foreclose and wreck it.” “As citizens of this great commonwealth,” said another, “we beg to add our gratitude and admiration for your untiring, brave, honest, and able devotion, which has preserved the Philadelphia & Reading Company intact, and has fairly started it on a broader career of usefulness.”204 Not less extraordinary was the further action of this harmonious meeting. In the first place, it authorized the creation of a collateral trust loan of $12,000,000 for the purpose of paying the floating debt, the balance due upon the purchase of Central Railroad Company of New Jersey stock, and the retirement of the outstanding income mortgage bonds. What, may be inquired, had become of the deferred income bonds of which Mr. Gowen had been so proud, and the $5,000,000 additional first series consols which with them were to cover the floating debt, if a new collateral loan was needed for the purpose for which they had been considered ample? As for the purchase of Jersey Central shares, an account would require a chapter in itself. The intent had been to secure more complete control of this subsidiary road. The purchase had been made on margin in May. By January, 1884, more funds were necessary to carry the stock; and as the business depression grew acute, the Reading was obliged to seek a time loan from Mr. Vanderbilt, and to pledge the purchased securities as collateral therefor. When the loan matured Reading was no better off than it had been before, and Vanderbilt, who seldom mixed philanthropy with business, sold the stock. The original purchase had been at 78; the prices obtained when the stock was thrown on the market ranged from 57 to 50, and the Reading lost the difference, besides those advantages which it had expected to gain.

In the second place, the meeting proposed a dividend of 21 per cent on the preferred stock, representing arrears due, and of 3 per cent on the common; both cash, and to be paid in case the collateral loan should succeed.205 In order to give shareholders time to consider, an adjournment was taken for two weeks, after which the dividend on the preferred stock was approved, though that on the common was not. It seems almost superfluous to insist upon the folly of this dividend. The Reading had not, in reality, “surmounted the difficulties of the last four eventful years.” Scarcely any of the benefits promised by Mr. Gowen’s plan of reorganization had been secured; fixed charges had not been reduced, because it had been found impossible to get creditors to take new securities in exchange for the old, and equally impossible to sell any considerable amount of the new securities for cash. While old charges had remained unabated, new charges had been added through the lease of the Jersey Central, new car trusts, and the like, and the very gain in earnings which might have been construed as favorable was due to increased mileage, and was not proportional to the growth of the system.206 A fitting sequel to Mr. Gowen’s words and acts was the scrip payment for labor and supplies which took place in May, 1884, and the accompanying fall in the prices of the company’s securities. On June 2 the company again passed into receivers’ hands. The same judges were applied to as in 1880, and the same receivers were appointed, except that Mr. Gowen, who had given up the presidency of the company, was replaced by Mr. George de Keim, his successor.207

The various creditors had now to do what should have been done before, and, by lightening the charges upon the road, to put it in a position where its solvency could be maintained. The chances for obtaining radical action from the bondholders were somewhat brighter, since even the most obstinate were being forced to realize that no halfway measures would avail; and a reasonable solution was even thus early hinted at in the suggestion that some of the bonds under which the road was staggering should be replaced by stock. Nevertheless, we shall find in this reorganization a slow working out of the requirements for a plan, and a slow process of at least partial reconcilement to the inevitable.

The receivers’ report was issued in October, but contained little not known or suspected before. From November 30, 1883, to June 2, 1884, there had been a net loss in operation for the Railroad Company of $2,322,282, and for the Coal & Iron Company of $1,049,702, showing conclusively the condition of the companies. The total bonded indebtedness was $94,613,042; a total to be compared with the $78,101,894 of four years previous. The total floating debt was $16,549,968 as compared with $10,254,766 at the beginning of the previous receivership. Including the Central of New Jersey, the total fixed charges for the Railroad and Coal & Iron Companies were $18,241,051; a sum which certain offsets, however, reduced to $16,584,732.208

The first suggestion for a reorganization came from a committee primarily representing the general mortgage bondholders, though including other interests as well. The chairman was Mr. Townsend Whelen, and the committee may be taken to represent the views of the management. “The present fixed charges of the company,” said Mr. Whelen, “are in round numbers $16,650,000, while the earnings of the past fiscal year are, in round numbers and after proper deductions, $12,900,000. The objects sought to be accomplished by the committee are:

“(1) To reduce fixed charges to the limit of last year’s earnings;

“(2) To preserve the proper order of priorities of each class of securities, so that no income applicable to any senior security that remains unpaid can by any possibility be diverted to paying the interest on a junior security;

“(3) To provide a method of paying the floating debt.”

The plan was, roughly, to leave the prior liens untouched, to fund one-half the coupons upon the general mortgage for three years, and to convert all of the other obligations into income bonds. Preferred stock was to be changed from cumulative to non-cumulative; rents of leased lines, including the Central of New Jersey, were to be reduced to the amounts which the properties had earned; the canal leases were to be reduced; the interest on some of the divisional coal land mortgages was to be reduced, and on some was to be paid in full. In regard to the floating debt the committee decided to postpone any attempt to raise money for its extinction. If the bondholders should accept the scaling down of their indebtedness, the company might have no difficulty in procuring cash by a collateral loan; if this should prove impossible, the duty of providing funds would devolve upon the junior securities.209 The committee found it impossible to prepare within the short time at their disposal a complete plan of reorganization with exact figures of present and proposed fixed charges; and it is therefore impossible to ascertain how great was the saving which they expected to secure.

The plan marks sufficiently well the advance which had been made since the reorganization of 1880–3. The best that could then be imagined had been the creation of a grand general mortgage for which the old bondholders might, but mostly did not, exchange their holdings; while now the very first suggestion endeavored to retain for all bondholders a chance for the same return as before, and found the salvation of the company in the transformance of certain bonds from mortgage to debenture obligations. The general criticisms which may be made are three: first, that it was unwise to defer all provision for the floating debt; second, that the new income bonds might better have been replaced by stock; and third, that the probable reduction in fixed charges would have been insufficient. So far as the committee suggested any action in relation to the floating debt, it favored a funding of it. This funding might have been either into mortgage or into income bonds: if the former, the fixed charges of the company would have been increased, or else the other mortgage bondholders would have been compelled to accept a lower rate of interest; if the latter, the volume of securities of slight value would have been increased, or the junior securities would have had to take less for their holdings. The action taken would have gone far to determine what classes of securities would assent, while in the absence of definite declaration it was on the whole likely that all classes would hold off. As for the income bonds, it is in general true that they are an unsatisfactory sort of security, and likely to hinder the legitimate increase of capital. Most important was the question of fixed charges. It will be remembered that of the first and second series 5s of the previous reorganization only $23,500,000 had been intended for immediate sale, and that of these but a portion had been disposed of; and yet these consols were the only securities the nature of which was really changed by the Whelen plan. Interest had been optional before on the income bonds, the convertible bonds, the convertible adjustment scrip, debenture and deferred income bonds; interest was not made optional on the general mortgage or prior liens. The result would not have been, in spite of the reduction in rents and the scaling of the divisional coal mortgages, any sufficient lessening of the fixed requirements. This fact was, moreover, perceived. The board of managers, to whom the scheme was reported, concluded a favorable opinion with the declaration, “to conclude, we are satisfied that the large economies already in operation, with those which are still being introduced, should be regarded as a margin to meet adverse contingencies.... That the revenue we reckon on, though reasonably certain under such reorganization, will surely not be realized in case the property should be torn asunder by foreclosure sale.”210 In other words they relied, much as Mr. Gowen had done two years before, on a subsequent increase in earnings to ensure the solvency of the company. A final objection made at the time was that the plan asked too little of the junior securities.